In life one of the most if not THE most important equation that needs to be solved is how much do I need for my retirement. The equation is not as simple as it seems as there are numerous variables that will undermine even the most detailed analysis. As we all know the inputs are; the size of the asset base, the annual returns on that asset base, the remaining life span of the investor and the annual expenses. These variables change constantly and therefore make it even more complex to determine the amount needed but financial planners like to assure investors that they are covered when often times they are not. I thought it would be useful to open pandora's box to show you how hard it is to determine the appropriate number and to make you consider in far more detail the inputs and the outputs before you make too bold a step into the world of retirement.
The first variable is the size of the portfolio. On this front it is always better to have more than not enough. To me the size of the portfolio needs to be of a size that will be resilient regardless of the market gyrations. There is no doubt that should you live another 20 years, the market will throw a spanner into your engine of returns and the draw down will destroy the supposed smooth line of returns that you are expecting. Just take the current market for example. For those that have followed this blog for some time you will know that I believe the market to be manipulated and over priced but the alternatives are producing such low rate of return that you are almost forced to take on too much risk to produce a meaningful number. This means that even now (or should I say especially now) the returns to your portfolio (if you want low risk which most retirees do) are too low to support any "normal" expenditure. One way around this is to invest outside the box but the other way is to have a portfolio that is so big that it does not matter.
Well as this is not a solution for most of us the next alternative is to delay your retirement as every year that you work not only adds to the size of the portfolio but also reduces the amount of time that the portfolio has to support you by one year. The less time that the portfolio is required to provide support the lower the size of the nest egg and/or the return requirement both of which are a huge benefit to your portfolio and its ability to achieve its goal.
The next thing to consider is the average annual return. As I have mentioned, achieving a meaningfully positive real rate of return (that is the portfolio return less inflation) is virtually impossible at present unless you take on far too much risk. Risk here is defined as the probability that your portfolio will suffer a large draw down from which it can never recover. Most people that I talk to seem to be in this camp as they are not considering the alternatives for the simple reason that their investment advisor is not able to sell them the alternative investments. This is a flaw in our investment system; the people that need the alternatives the most are "protected" from them so that they are not exposed to losses. In the meantime they are lead to the slaughter like lemmings but those are the rules and I pity those that are forced to follow them.
The next point regarding returns is that they will change year in and year out. The idea of a smooth line is almost impossible to achieve so the portfolio has to be able to sustain a draw down and recover. This is why the average planner suggests that retirees only withdraw 4% of their portfolio each year. This small amount protects the portfolio but often reduces the amount that the retiree can withdrawal to such a small amount that it does not benefit the retiree at all. Assume you retire on $500,000 and you can withdraw 4% a year, that is only $20,000 a year or roughly $1,800 a month. While not a small amount it is not big enough to support most active lifestyles and most retirees do not even have half this amount saved!
Looking at life expectancy tables shows that the older you are the longer you have to live. So for example at 50 the tables show that you have roughly 35 years to left live but if you are 85 the tables do not show zero years to live but show roughly 10 years left. The probability that you will live longer is higher the older you get and therefore to plan your retirement requires a constant adjustment to your life expectancy all the while your portfolio size is finite (other than the returns on it).
The final input is the monthly expenses. While we all know that 95% of our medical expenses are incurred in the last 5 years of life what most planners do not factor is that spending habits change with the size of the portfolio. People are not going to blindly spend the same amount of money each year particularly if the portfolio size diminishes rapidly due to unforeseen market forces. People will adjust their spending down as the fear of outliving their income will quickly place a crimp on the spending. The main issue here is that the catch all, annuities, are not factoring a lot of these inputs as there simply has not been enough time (and here I mean enough years to have past to produce data) to capture the data required to factor in all of these inputs with a sufficient level of understanding to underwrite the majority of the risks. Not that I expect the annuity world to blow up but it is something to consider when you are told that you are covered because you have an annuity.
So with all of this said it is really clear why you need to constantly review your investment portfolio as there are no constants even if your planner assures you that they have it covered!
Friday, April 29, 2016
Friday, April 8, 2016
Controlled versus Free Markets
Having no trade restrictions; not subject to government regulation; not subject to restriction or official control. - one of the definitions of Free in the Webster Dictionary
During the week I spend a lot of time reading to keep up with the ins and outs of the markets and the macro-economic environment. I do so to try to assist me in planning my next move but as most macro-economic moves take time to develop I am not in a rush to change things. It has been my contention that the United States and the world are in a predicament that will lead to severe pain so for the past five years I have been slowly implementing an investment strategy that I believe will benefit from my macro-economic outlook. Most people do not want to hear my views as they are contrary to what the talking heads want you to believe and the results, if I am right, are painful but in this game you need to do your research and follow your findings in order to succeed.
This week I have been reviewing a number of articles associated with the idea of a free market. When I first started trading back in the early 80's the markets gave you ample opportunity to prosper from good solid research. Since then almost 40 years later those days are long gone. With the advent of the massive control that the Federal Reserve and other central bankers now have over the markets the game has changed. So the idea of a free market no longer exists. As the rules of the game have changed the investment strategies need to align themselves with the new playing field so let's look at the playing fields.
A free market as the definition above shows is one where there is no government intervention. Markets are left to their own devises. They will move to the beat of the economic environment and the perceived opportunities available to the companies that operate in their various sectors. When there are good times stock prices run higher as the outlook is solid and profits rise. During these times more and more companies enter the space eventually stealing market share from the incumbents and hurting the bottom line of all businesses in that space. The effect of this competition is lower prices to the consumer and expanding employment. Eventually though when the profits are too thin the weak are weeded out, layoffs and bankruptcies become the norm. Once these are cleared out the cycle repeats itself. Market forces take care of the good times and the bad times.
Fast forward to today where there is a shrinking pool of large companies that control larger and larger portions of the global market. Profits are spent not on research and development but on securing their position in the world by creating, as Warren Buffet terms, a "moat" around their business impregnable to others. The result is higher prices to consumers and lower employment opportunities. These companies can handle the down turns but due to the lack of competition during recoveries there is little in the way of employment growth. The only growth that is seen is profits.
In addition you have a Federal Reserve that is becoming more and more like the central planners of Russia and China. They are not content to let the market operate in a vacuum but tinker with its very existence by lowering rates to juice returns to investors and providing cheap capital to the too big to fail companies. The result is that the rich who benefit from these interventions get richer and the poor feel no effect of the "stimulus". At present there is an ever wider dispersion between the wealthy and the poor and this disparity is creating massive problems for growth and political stability.
This intervention is not limited to the United States but has expanded across the globe. In Japan the BOJ has not only issued debt but now owns around 40% of all the exchange traded funds on the Japanese stock markets. Furthermore they are demanding new funds be made up of socially responsible companies (read companies that benefit the Japanese people) so they are not only providing capital but are controlling the intricate workings of the stock market itself. China too has manipulated their markets more aggressively than the Federal Reserve but it is clear that they all have their arms firmly grasped around what used to be a free market.
In the volumes of historical documentation about the central planners of the world it is clear that any time a country pursues a path of central control, or control among the few, it never succeeds in the long run. There may be some short term gains but eventually it all craters. Russia blew apart, China is showing signs of instability and needs to open up to a freer market. Japan is still struggling to stimulate inflation. The issue is that the worse things get the tighter the central bankers' control over the market. I have written much since the 2008 crisis and a lot of what was written was the question why, after the crisis was averted, did the Federal Reserve not move to the side? Their job was done and it was now up to the markets to take over and sort the balance of the problems out themselves, freely; but they have continued to meddle and try to control the markets and their continued tinkering is creating the massive market instability that we face today.
The result is going to be a very bad market collapse. The issue is that this will stimulate them to try to control the market even tighter than before. At some point congress will have to step up and remove the ridiculous powers of the Federal Reserve and restore them to their previous mantra of fighting inflation and lowering unemployment, freeing the markets from their grasp. Until then my thought is that the global economy will continue to dribble forward on life support with longer recessions and little in the way of any economic recovery, forever.
Friday, April 1, 2016
The Obesity Index
"This is what people don't understand: obesity is a symptom of poverty. It's not a lifestyle choice where people are just eating and not exercising. It's because kids - and this is a problem with the school lunch right now - are getting sugar, fat, empty calories - lot's of calories - but no nutrition." - Tom Colicchio
Well the world's central bankers could learn a thing or two from the above statement however their "obesity" is in the form of debt. A recent article published in the CFA magazine highlights that global debt has risen by $57 trillion between 2007 and 2014. That is more than $8 trillion a year added or roughly $700 billion a month! This puts global debt at more than 286% of global GDP. The sad part is this number only counts the debt that has been issued and does not include what is referred to as "off balance sheet" debt. These are debt obligations that are owed but have not yet been paid and have no formal debt associated with it. Examples of this kind of debt would be the unfunded Social Security benefits, pension liabilities and entitlement programs. If we were to include these obligations the number would be far greater. Just taking the pension obligations the estimate is $50 trillion more pushing debt to global GDP over 300%.
This has not deterred the globe's central bankers from issuing more debt. The reasoning seems to be that if the world has taken on this much debt what does it matter if we take on more? Furthermore, without this infusion of capital in the form of debt the global economy would not be growing and we would be in a world of trouble, so the central bankers say. But there are two main problems associated with this continued increase in the debt burden; the first is that borrowing no longer generates growth and the second is that instability is increasing.
Taking the first issue regarding the lack of growth, I do not know how much more of an example is required than the post Great Recession's anemic recovery. As the debt level rises more and more money is spent on servicing the debt and ultimately it crowds out productivity. Back in the 80's when debt was first added as a stimulant each unit of additional debt resulted in roughly a unit increase of productivity. Today that marginal productivity has all but evaporated. Adding more debt is have no impact on growth which is why no matter how much money is thrown at the problem or how low interest rates go there is no economic expansion.
The second issue is that as you pile more and more debt onto the world it results in shorter boom periods and longer periods of bust and recovery. Defaults are becoming more and more common and people are becoming more and more angry at the establishment and the rules; just look at the mess created by the massive obligation of student loans in the United States. This instability is feeding into politics as angry voters throw their weight behind people like Trump.
To me adding more debt to the global economy is like piling more sand onto a sand castle, eventually it will buckle under its own weight. A reverse strategy would be far more effective and stimulating. Imagine if the United States wrote off all of the student debt in one go. All of that money would be spent on housing, cars, vacations and the like. The stimulus would be huge. Any consumer knows that removing the burden of debt brightens your whole day, the outlook is not cloudy and your are excited to buy something new. Unfortunately the world has burdened its citizens with the yoke of debt and until this is lifted global economic growth will remain anemic.
If growth therefore is anemic (as it has been) and good paying jobs hard to find (as they are), the world's middle class will continue to shrink as people roll backwards. In order to stave off the debt collector families are cutting expenditure (creating slow to no economic growth) and, according to the quote above this is one of the main causes of obesity. Hence the birth of a new index, the Obesity Index. If obesity continues to grow economic "stimulus" is not working. Once there is true economic growth you should start to see obesity come under control. As it is now a growing global problem it would point to continued poor economic growth and a disconnect between the policies of the central bankers of the world and the impact of their "stimulus" on the global economy.
Until such time as there is true global economic expansion, not growth based on fictitious money that is blindly thrown at banks, but real expansion based on growing consumer spending derived from wage increases and jobs, I guess the world will continue to consume the $1 Big Mac and deal with its waistline!
Well the world's central bankers could learn a thing or two from the above statement however their "obesity" is in the form of debt. A recent article published in the CFA magazine highlights that global debt has risen by $57 trillion between 2007 and 2014. That is more than $8 trillion a year added or roughly $700 billion a month! This puts global debt at more than 286% of global GDP. The sad part is this number only counts the debt that has been issued and does not include what is referred to as "off balance sheet" debt. These are debt obligations that are owed but have not yet been paid and have no formal debt associated with it. Examples of this kind of debt would be the unfunded Social Security benefits, pension liabilities and entitlement programs. If we were to include these obligations the number would be far greater. Just taking the pension obligations the estimate is $50 trillion more pushing debt to global GDP over 300%.
This has not deterred the globe's central bankers from issuing more debt. The reasoning seems to be that if the world has taken on this much debt what does it matter if we take on more? Furthermore, without this infusion of capital in the form of debt the global economy would not be growing and we would be in a world of trouble, so the central bankers say. But there are two main problems associated with this continued increase in the debt burden; the first is that borrowing no longer generates growth and the second is that instability is increasing.
Taking the first issue regarding the lack of growth, I do not know how much more of an example is required than the post Great Recession's anemic recovery. As the debt level rises more and more money is spent on servicing the debt and ultimately it crowds out productivity. Back in the 80's when debt was first added as a stimulant each unit of additional debt resulted in roughly a unit increase of productivity. Today that marginal productivity has all but evaporated. Adding more debt is have no impact on growth which is why no matter how much money is thrown at the problem or how low interest rates go there is no economic expansion.
The second issue is that as you pile more and more debt onto the world it results in shorter boom periods and longer periods of bust and recovery. Defaults are becoming more and more common and people are becoming more and more angry at the establishment and the rules; just look at the mess created by the massive obligation of student loans in the United States. This instability is feeding into politics as angry voters throw their weight behind people like Trump.
To me adding more debt to the global economy is like piling more sand onto a sand castle, eventually it will buckle under its own weight. A reverse strategy would be far more effective and stimulating. Imagine if the United States wrote off all of the student debt in one go. All of that money would be spent on housing, cars, vacations and the like. The stimulus would be huge. Any consumer knows that removing the burden of debt brightens your whole day, the outlook is not cloudy and your are excited to buy something new. Unfortunately the world has burdened its citizens with the yoke of debt and until this is lifted global economic growth will remain anemic.
If growth therefore is anemic (as it has been) and good paying jobs hard to find (as they are), the world's middle class will continue to shrink as people roll backwards. In order to stave off the debt collector families are cutting expenditure (creating slow to no economic growth) and, according to the quote above this is one of the main causes of obesity. Hence the birth of a new index, the Obesity Index. If obesity continues to grow economic "stimulus" is not working. Once there is true economic growth you should start to see obesity come under control. As it is now a growing global problem it would point to continued poor economic growth and a disconnect between the policies of the central bankers of the world and the impact of their "stimulus" on the global economy.
Until such time as there is true global economic expansion, not growth based on fictitious money that is blindly thrown at banks, but real expansion based on growing consumer spending derived from wage increases and jobs, I guess the world will continue to consume the $1 Big Mac and deal with its waistline!
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