"The quality, not the longevity, of one's life is what is important." - Martin Luther King, Jr.
I don't think I have ever said that my blog is a must read but if you are approaching, planning for, or in retirement then this blog is a must read. Trying to make our retirement dollars last through our remaining life expectancy is one of the most important considerations that we have. Not running out of money before you die has to be a priority and therefore maximizing your retirement dollar is critical.
In an excellent article in the Financial Analysts Journal by Kirsten Cook, William Meyer and William Reichenstein, the authors present a methodology for extending your investment portfolio without changing your investment strategy or the amount that you have invested but by simply using the tax code to your advantage. Now some of my international readers may think this does not apply to them but I am sure that reading this article will spark some ideas that you can use at home to assist your portfolio.
The common rule of thumb is that in retirement you should first exhaust your taxable investments (TI), then your tax deferred investments (TDI) and finally your tax exempt investments (TEI). The authors of the article point out that if the tax rate is flat there is no difference between the TDI or the TEI, It is only when there is a progressive tax structure (such as the one in the United States) where a difference exists. In a flat tax environment whether you have a TDI or a TEI account will result in the same net amount. You can try it on a calculator if you like but believe me placing an amount net of tax into a TEI and growing it at a set interest rate for any amount of time will give you the same result as placing the whole amount into at TDI and withdrawing the total amount and deducting the same tax rate as before. In this environment it makes no difference which tax protected account you withdraw from first. The only way you can extend your dollars is by drawing down on your TI portfolio first.
Turning to the progressive tax environment results in a completely different equation. As before drawing down on your TI first is a must but after that things get interesting. The first thing to determine is the total amount that can be withdrawn before you trigger the next higher tax bracket. Once you have these amounts you can start to plan and it is surprising to discover that the optimal tax strategy may be to withdraw amounts from your TDI before it is required. The authors in fact discovered that the optimal strategy is one where you convert two or more blocks of your TDI portfolio into TEI investments. This is allowed as a Roth conversion in the United States. Each block needs to be placed in its own separate account. The accounts are opened and funded at the beginning of the year with investments from the TDI portfolio. Each allocation amount is the maximum allowed in the lowest (or second lowest depending on the size of the portfolio) tax bracket. So for example in the United States in 2013 an individual could have placed $47,750 and only triggered the second tax bracket of 15%. At the end of the year the converted TEI with the highest value is left as a TEI and the others are reconverted back to the TDI therefore only one conversion is taxed. Doing this throughout the portfolio extended the life of the portfolio by an average of 6.5 years!
So you may be asking why even have a TDA why not invest everything into a TEI? The answer is that there are benefits to the TDA in that you should be able to fund it with more money as you did not need to pay tax on the money before funding and this larger amount will grow tax deferred therefore growing to a larger ending balance than the TEI. The key then is trying to minimize the tax burden on the withdrawals from this investment and I have shown you one clever technique above. A second technique is to maximize the withdrawals on this account in any year where you have large expenses such as medical bills that will offset the tax paid on this withdrawal. Doing this will also extend the life of the portfolio.
So while I do not typically like to delve into taxes this is an excellent way to stretch the life of the portfolio and this could be critical to some of us. Furthermore having investments in TDI and TEI investments can be beneficial so do not steer everything away from the standard TDI investments as these can provide a higher value and if planned for correctly should not cause you too many tax nightmares. In the meantime as I have now stretched out your portfolio I think you and I better start limbering up our bodies so that we can enjoy the extra years.
Friday, March 27, 2015
Friday, March 20, 2015
Helping or Hurting?
"The biologist and intellectual E.O. Wilson was once asked what represented the most hindrance to the development of children; his answer was the soccer mom. But the problem is more general; soccer moms try to eliminate the trial and error, the antrifragility, from children's lives, move them away from the ecological and transform them into nerds working on preexisting (soccer-mom-compatible) maps of reality. They are now totally untrained to handle ambiguity." - Nassim Taleb from his book Antifragile
While the quote above is directed at soccer moms I personally think that it could just as easily have been directed at modern day dads or parents as a group. As parents we love to give our kids a helping hand and mostly this is fine but often times the giving is taken too far and for too long and not only does this jeopardize our retirement but it also gives our kids a false sense of entitlement and security (they become fragile) and this is bad for the parents and their offspring. A study showed that the average retiree in the United States has $111,000 in their retirement account at retirement age. A rule of thumb is that you can fund your retirement with roughly 4% of this balance each year meaning that the average American can only draw $4,440 a year or $370 a month from this balance. This is hardly enough to pay the groceries for a month let alone service the mortgage, car payments, taxes, medical care and any form of meals and entertainment. However regardless of this 1 in 3 parents are providing financial assistance to adult children. In comparison only 1 in 5 provides support to their parents so the argument that your kids will support you holds little water.
Well I am certainly not saying pull the rug out from under your children's feet but I would definitely make sure that you can afford the support that you are giving. I have numerous examples of couples in the retirement age bracket that continue to work 50 plus hours a week to not only maintain their life style but the life style of their grown kids. This is crazy. Not only does this hurt you but it also hurts the kids. It hurts you because you are unable to put aside the amount required to retire and it hurts your kids because you are teaching them to live a life beyond their means so when the day finally does arrive where you can no longer work both of you instantly have the rug pulled out from under you.
My thought is to allocate spending on your kids in ways that benefit them *(make them antifragile). Our job as parents is to give our kids the best chance to succeed and so for example spending on a child's education is certainly one way that can achieve this goal. On the flip side paying their rent, buying them chic clothes or a flash car is tantamount to feeding animals in the wild. It is detrimental to both of you - in the wilds not only does the animal become dependent on the handouts but it becomes aggressive attacking people when it becomes hungry. Now I am not opposed to the odd handout at say their birthday but making monthly payments to support a life style that neither they nor you can afford is completely ridiculous.
It appears that parents are doing everything possible to protect their kids from the evils of the world including making sure that when they leave the house that their baby is taken care of financially so they can live like they did at home. While an admirable goal it is foolish and does not help them in the long run. Worse still if you empty the piggy bank you are now a huge burden on them (assuming they actually help you which as the earlier paragraph shows is a long shot) and their income so you actually end up dragging everyone down with you. This I am certain is not what the intention is so in order to help everyone in the family make sure you are setting aside enough to remove this potentially huge burden. Help yourself to help them and who knows in the end they may receive a nice handout when you die and they find that the coffers are not empty. Now that would be far more beneficial to all!
While the quote above is directed at soccer moms I personally think that it could just as easily have been directed at modern day dads or parents as a group. As parents we love to give our kids a helping hand and mostly this is fine but often times the giving is taken too far and for too long and not only does this jeopardize our retirement but it also gives our kids a false sense of entitlement and security (they become fragile) and this is bad for the parents and their offspring. A study showed that the average retiree in the United States has $111,000 in their retirement account at retirement age. A rule of thumb is that you can fund your retirement with roughly 4% of this balance each year meaning that the average American can only draw $4,440 a year or $370 a month from this balance. This is hardly enough to pay the groceries for a month let alone service the mortgage, car payments, taxes, medical care and any form of meals and entertainment. However regardless of this 1 in 3 parents are providing financial assistance to adult children. In comparison only 1 in 5 provides support to their parents so the argument that your kids will support you holds little water.
Well I am certainly not saying pull the rug out from under your children's feet but I would definitely make sure that you can afford the support that you are giving. I have numerous examples of couples in the retirement age bracket that continue to work 50 plus hours a week to not only maintain their life style but the life style of their grown kids. This is crazy. Not only does this hurt you but it also hurts the kids. It hurts you because you are unable to put aside the amount required to retire and it hurts your kids because you are teaching them to live a life beyond their means so when the day finally does arrive where you can no longer work both of you instantly have the rug pulled out from under you.
My thought is to allocate spending on your kids in ways that benefit them *(make them antifragile). Our job as parents is to give our kids the best chance to succeed and so for example spending on a child's education is certainly one way that can achieve this goal. On the flip side paying their rent, buying them chic clothes or a flash car is tantamount to feeding animals in the wild. It is detrimental to both of you - in the wilds not only does the animal become dependent on the handouts but it becomes aggressive attacking people when it becomes hungry. Now I am not opposed to the odd handout at say their birthday but making monthly payments to support a life style that neither they nor you can afford is completely ridiculous.
It appears that parents are doing everything possible to protect their kids from the evils of the world including making sure that when they leave the house that their baby is taken care of financially so they can live like they did at home. While an admirable goal it is foolish and does not help them in the long run. Worse still if you empty the piggy bank you are now a huge burden on them (assuming they actually help you which as the earlier paragraph shows is a long shot) and their income so you actually end up dragging everyone down with you. This I am certain is not what the intention is so in order to help everyone in the family make sure you are setting aside enough to remove this potentially huge burden. Help yourself to help them and who knows in the end they may receive a nice handout when you die and they find that the coffers are not empty. Now that would be far more beneficial to all!
Friday, March 13, 2015
Too Big to Save
"There aren't enough lifeboats. Someone is going to die. So you might as well enjoy the champagne and caviar." - Jamie Dimon, CEO of JP Morgan Chase to his staff the night before Lehman filed for bankruptcy
In the argument over banks being too big to fail it seems that there are a few key missing pieces of information. First off is that one of the large banks will fail again at some point in the future regardless of what regulations are put into place. I am certainly not saying that it will happen tomorrow but it will happen, there is no question about this. Why am I so sure? First history has a tendency to repeat itself and second bankers by their very nature are intent on maximizing profits. In order to maximize profits risk has to be taken and leverage is often used. Normal banking leverage is already high when compared to the rest of society (10 to 1; even your riskiest stock broker will only give you 2 to 1) and this level pails into insignificance when taken up to the derivative trades made off balance sheet. In fact when you look off balance sheet you find trades with leverage in the magnitudes of 1,000s of times the global GDP! One small shake of this stick and everything collapses but that is for a different blog post. The point to the argument is that one or many major too big to fail banks will at some point in time collapse.
The second problem is that as global trade becomes more and more interrelated and borders are crossed at will by large corporations, they will require banks that can manage the complexities associated with each countries regulators. If you were the CEO or Treasurer of Apple for example would you want to have a new bank account at a new bank in each country where the company's products are sold or would you rather go to JP Morgan and have them open a branch next to your satellite head quarters in each country, consolidate all the cash balances in one statement and provide you instant access to monitor the situation in any branch around the globe? Of course you would choose the second option meaning that big banks are not only here to stay I expect them to get bigger.
So it really is not a question of creating regulations to make banks smaller but to me trying to ensure that should a large bank fail that it does not impact the lives of ordinary citizens. A simple solution is to regulate banks so that their growth is restricted based on their chosen types of operations. So for example let's say that bank one provides our Apple Treasurer with everything that he needs and remains a plain vanilla bank that operates in a multitude of countries. One could argue that as the bank is not involved in trading or underwriting or derivative transactions that the risk of the bank failing is limited. In this case holding a 10% reserve requirement seems reasonable and should protect investors and the globe against the fallout should the bank fail. The bank is still huge and could be considered too big to fail but the impact should it fail should be minimal.
On the opposite side of the equation bank two provides not only the normal banking functions but behind the scenes is anything but a a bank (in its true form) but is rather a banking hedge fund where the majority of its results are derived from trading and other gambling style investments. This bank obviously has a higher level of risk associated with its survival and should therefore not only hold significantly higher reserves but should also have to show regulators how the pipes that connect them to the rest of the banking community will continue to operate should they vaporize. Assuming that the pipes will continue to operate without them then the systemic risk is relieved. Now this is really easy to put into print and virtually impossible to do right now but in reality if the penalties were such that if the bank cannot show a way to allow the rest of the banking world to function without them then it would be a relatively easy job to raise the level of reserves required by the bank until such time as they can show this ability. One thing I do know is that if the tables are turned, the bank will work out a solution.
So instead of regulators running around in a desperate attempt to reign in something they will never keep abreast of and forcing a size constraint on an operation that is required to keep the global economy functioning and growing; I believe that it is time to turn the tables and create a simple solution of too big to save. Any bank that falls under this heading (and they are not hard to spot) has a simple choice, raise the reserve requirements to unheard of levels or off load those operations. These banks would then be left to fail next time around. The funny thing is with the safety net removed I would not be surprised to see banks change their colors pretty quickly. As an example, if a banks operations make it risky and the face value of its derivative portfolio are larger than 20% of global GDP then it becomes too big to save. At this point the bank must either tone it down or post 30% reserves with the IMF or the Federal Reserve. Once it can control its greed then it can go back to business as normal. The current discussions on too big to fail are failing themselves, wasting tax payer money and will not result in a solution to the problem for the simple reason that, as has happened throughout history, the regulated problems of the past will be superseded in the blink of an eye as the banks will have morphed into something new and unregulated.
It is time to move on from too big to fail and realize that regulations should be designed around too big to save!
In the argument over banks being too big to fail it seems that there are a few key missing pieces of information. First off is that one of the large banks will fail again at some point in the future regardless of what regulations are put into place. I am certainly not saying that it will happen tomorrow but it will happen, there is no question about this. Why am I so sure? First history has a tendency to repeat itself and second bankers by their very nature are intent on maximizing profits. In order to maximize profits risk has to be taken and leverage is often used. Normal banking leverage is already high when compared to the rest of society (10 to 1; even your riskiest stock broker will only give you 2 to 1) and this level pails into insignificance when taken up to the derivative trades made off balance sheet. In fact when you look off balance sheet you find trades with leverage in the magnitudes of 1,000s of times the global GDP! One small shake of this stick and everything collapses but that is for a different blog post. The point to the argument is that one or many major too big to fail banks will at some point in time collapse.
The second problem is that as global trade becomes more and more interrelated and borders are crossed at will by large corporations, they will require banks that can manage the complexities associated with each countries regulators. If you were the CEO or Treasurer of Apple for example would you want to have a new bank account at a new bank in each country where the company's products are sold or would you rather go to JP Morgan and have them open a branch next to your satellite head quarters in each country, consolidate all the cash balances in one statement and provide you instant access to monitor the situation in any branch around the globe? Of course you would choose the second option meaning that big banks are not only here to stay I expect them to get bigger.
So it really is not a question of creating regulations to make banks smaller but to me trying to ensure that should a large bank fail that it does not impact the lives of ordinary citizens. A simple solution is to regulate banks so that their growth is restricted based on their chosen types of operations. So for example let's say that bank one provides our Apple Treasurer with everything that he needs and remains a plain vanilla bank that operates in a multitude of countries. One could argue that as the bank is not involved in trading or underwriting or derivative transactions that the risk of the bank failing is limited. In this case holding a 10% reserve requirement seems reasonable and should protect investors and the globe against the fallout should the bank fail. The bank is still huge and could be considered too big to fail but the impact should it fail should be minimal.
On the opposite side of the equation bank two provides not only the normal banking functions but behind the scenes is anything but a a bank (in its true form) but is rather a banking hedge fund where the majority of its results are derived from trading and other gambling style investments. This bank obviously has a higher level of risk associated with its survival and should therefore not only hold significantly higher reserves but should also have to show regulators how the pipes that connect them to the rest of the banking community will continue to operate should they vaporize. Assuming that the pipes will continue to operate without them then the systemic risk is relieved. Now this is really easy to put into print and virtually impossible to do right now but in reality if the penalties were such that if the bank cannot show a way to allow the rest of the banking world to function without them then it would be a relatively easy job to raise the level of reserves required by the bank until such time as they can show this ability. One thing I do know is that if the tables are turned, the bank will work out a solution.
So instead of regulators running around in a desperate attempt to reign in something they will never keep abreast of and forcing a size constraint on an operation that is required to keep the global economy functioning and growing; I believe that it is time to turn the tables and create a simple solution of too big to save. Any bank that falls under this heading (and they are not hard to spot) has a simple choice, raise the reserve requirements to unheard of levels or off load those operations. These banks would then be left to fail next time around. The funny thing is with the safety net removed I would not be surprised to see banks change their colors pretty quickly. As an example, if a banks operations make it risky and the face value of its derivative portfolio are larger than 20% of global GDP then it becomes too big to save. At this point the bank must either tone it down or post 30% reserves with the IMF or the Federal Reserve. Once it can control its greed then it can go back to business as normal. The current discussions on too big to fail are failing themselves, wasting tax payer money and will not result in a solution to the problem for the simple reason that, as has happened throughout history, the regulated problems of the past will be superseded in the blink of an eye as the banks will have morphed into something new and unregulated.
It is time to move on from too big to fail and realize that regulations should be designed around too big to save!
Friday, March 6, 2015
What's in a Number?
0 is the additive identity; 1 is the multiplicative identity; 2 is the only even prime number; 3 is the number of spacial dimensions we live in; ....; 5,000 is the largest number whose English name does not repeat any letters; ...; 5,048 is the number of strongly connected digraphs with 5 vertices (and I thought it was the number associated with the all time NASDAQ high)
With the NASDAQ bumping up against its all time highs I thought it pertinent to take a look at the index and explain why the excitement regarding this number is really just a sales pitch rather than a meaningful indicator of the business and investment environment.
In March 2000 the NASDAQ hit its all time high of 5,048.62. Fifteen years later (almost to the day) the NASDAQ managed to reach 5,000 but has not managed to close above the all time high - YET. I say yet because it appears that the market manipulators are hell bent on getting all the indices to produce all time highs; it makes for better cheer leading opportunities!
So digging into the NASDAQ a number of things pop right out. First off the index now only consists of 43% tech stocks whereas back in 2000 it was almost 65% technology. Second the index constantly changes the companies that it incorporates into the index. Had the same companies remained in the index that were there in 2000 the index would still be miles from its high. Back then companies like PMC Sierra, JDS Uniphase, Sycamore and Juniper Networks were pushing the index at a huge clip. Today Sycamore is gone completely and the other three are limping along at fractions of their all time highs. Only tree of the top 10 companies from 2000 are still in the top 10 now (Microsoft, Intel, Cisco) and all three of them are still a long way from the heady highs of 2000. So the index now relies on a new breed of companies to generate returns. Apple has sprung from almost non-existent to the largest company in the world; Google, Facebook and Amazon have all come through the ranks and now fill up the top five spots with Microsoft.
A third difference is that (according to the pundits) the Price to Earnings ratio (P/E) is far lower today than it was then so there is no bubble. now while I am not contending that a bubble exists the P/Es are still elevated. Apple is at 18, Google at 26, Facebook at 72 and Amazon does not have one as it is not profitable (sound familiar). When you raise up the hood to take a deeper look and find companies like Twitter, Tesla and others it starts to look almost identical! So while it might appear that things are different this time in terms of valuation they are scarily similar.
Fourth, in terms of a recovery, making it back to 5,000 is hardly a resounding success. Factoring in a mild form of inflation would mean that the index should be at around 7,000 for an investor to break even and we are a long way from there. To think that it has taken more than $4 Trillion in Federal Reserve stimulus and all we have to show is the media frenzy over a meaningless number is sad to say the least and with the reduction in Fed stimulus it appears that 5,048.62 may be the hardest hurdle to cross but I have to believe that having forced the bar this high they will not stop until the trumpets are sounding from Wall Street.
So when it comes down to it this number is meaningless unless you are a marketing person on Wall Street. It is not going to change the economic landscape and it is not signalling a new investment era but rather, scarily, it might be signalling a return to the bad old days.
With the NASDAQ bumping up against its all time highs I thought it pertinent to take a look at the index and explain why the excitement regarding this number is really just a sales pitch rather than a meaningful indicator of the business and investment environment.
In March 2000 the NASDAQ hit its all time high of 5,048.62. Fifteen years later (almost to the day) the NASDAQ managed to reach 5,000 but has not managed to close above the all time high - YET. I say yet because it appears that the market manipulators are hell bent on getting all the indices to produce all time highs; it makes for better cheer leading opportunities!
So digging into the NASDAQ a number of things pop right out. First off the index now only consists of 43% tech stocks whereas back in 2000 it was almost 65% technology. Second the index constantly changes the companies that it incorporates into the index. Had the same companies remained in the index that were there in 2000 the index would still be miles from its high. Back then companies like PMC Sierra, JDS Uniphase, Sycamore and Juniper Networks were pushing the index at a huge clip. Today Sycamore is gone completely and the other three are limping along at fractions of their all time highs. Only tree of the top 10 companies from 2000 are still in the top 10 now (Microsoft, Intel, Cisco) and all three of them are still a long way from the heady highs of 2000. So the index now relies on a new breed of companies to generate returns. Apple has sprung from almost non-existent to the largest company in the world; Google, Facebook and Amazon have all come through the ranks and now fill up the top five spots with Microsoft.
A third difference is that (according to the pundits) the Price to Earnings ratio (P/E) is far lower today than it was then so there is no bubble. now while I am not contending that a bubble exists the P/Es are still elevated. Apple is at 18, Google at 26, Facebook at 72 and Amazon does not have one as it is not profitable (sound familiar). When you raise up the hood to take a deeper look and find companies like Twitter, Tesla and others it starts to look almost identical! So while it might appear that things are different this time in terms of valuation they are scarily similar.
Fourth, in terms of a recovery, making it back to 5,000 is hardly a resounding success. Factoring in a mild form of inflation would mean that the index should be at around 7,000 for an investor to break even and we are a long way from there. To think that it has taken more than $4 Trillion in Federal Reserve stimulus and all we have to show is the media frenzy over a meaningless number is sad to say the least and with the reduction in Fed stimulus it appears that 5,048.62 may be the hardest hurdle to cross but I have to believe that having forced the bar this high they will not stop until the trumpets are sounding from Wall Street.
So when it comes down to it this number is meaningless unless you are a marketing person on Wall Street. It is not going to change the economic landscape and it is not signalling a new investment era but rather, scarily, it might be signalling a return to the bad old days.
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