Yesterday I recounted a great story in Consumer Reports called “12 Money Mistakes That Could Cost You $1,000,000”? A million bucks within your grasp! The two that stick out are the ones that carry the biggest bang for the buck. I started with investing too conservatively during retirement and today we move on to the elephant in the room for most pre-retirees: Retiring before you need to.
Whenever people come in to discuss various investment strategies to enhance retirement portfolio returns, I like to remind them that they control the two most important variables of retirement planning: retirement date and spending needs. I know that it’s hard to accept this, but it is more important when and how you retire than whether you have a four or five-star rated mutual fund in your portfolio.
The first hurdle is reaching your full Social Security retirement age so that you can maximize your benefits and qualify for Medicare. If you are planning to retire prior to that time and grabbing a smaller Social Security check, remember that by doing so, you will permanently reduce your (and your non-working spouse’s) retirement benefits. And if you are not eligible to be in the Medicare program, you may have the additional cost of individual health insurance. Some have pointed out to me that if they die early, then early SS is worth it. Call me crazy, but somehow premature death does not seem like a prize.
Perhaps of greater importance than the simple math associated with Social Security, is when you retire early you are foregoing your income during what may be some of your highest earning years. And of course without that income, you will start dipping into your savings and investments. Consumer Reports tried to quantify the early retirement decision by analyzing a hypothetical $54,592 (the median U.S. household income for 62-year olds). Assuming Mr. Early- Retirement stopped working at the beginning of 2008 at 62 and started to collect SS, his reduced benefits and private health insurance, plus his four years of lost income (including 4% annual raises) cost him approximately $237,000-$309,000.
Need I point out that it is very difficult to earn hundreds of thousands of dollars on a risk-free basis? Given the amount of time and energy that everyone spends on contemplating retirement, one of the easiest solutions may be the one you don’t want to hear: keep working!
Friday, March 14, 2008
Thursday, March 13, 2008
Consumer Reports’ Money Mistakes 1
I like a catchy headline, which is why I picked up Consumer Reports for the first time since purchasing a car a few years ago. Who would not want to know the “12 Money Mistakes That Could Cost You $1,000,000”? I can’t give away all of the mistakes, but two in particular should be shouted from the mountaintops across the nation.
According to the Consumer Reports “Money Lab”, the number one, costliest mistake that people make is investing too conservatively during retirement. I have seen this problem first-hand – as people retire, they abandon riskier assets like stocks and allocate much of their portfolio in bonds or cash. I always try to explain that for most people, this decision can be problematic. The reason is that the number one goal of retirement portfolio allocation is to keep pace and hopefully beat inflation. To do this, you probably need a broadly-diversified portfolio, which means that you can not abandon risk all together.
Conventional wisdom has long suggested that as retirees age, they should shift money out of stocks and into more stable investments, such as bonds or certificates of deposit (CDs). But the problem with that philosophy is that those safer instruments’ annual returns may barely keep pace with inflation, while stocks, over time, typically provide returns significantly above inflation. And inflation can be a retiree's worst enemy.Consumer Reports teamed up with investment-research firm Ibbotson Associates, to back test the idea of a diversified portfolio using data from 1940 through 2006. In the exercise, they assumed that the investor retired at 65 with $500,000 in savings to invest. They also factored in that the retiree would need to pull some money out of the portfolio at a rate of 3 percent each year during retirement and adjusted returns for inflation. The results were impressive: “we found that an asset mix leaning more toward Standard & Poor's 500 stock index than bonds provided bigger returns and annual cash draws…the team estimates that the cost of this mistake to people who are risk-averse to be in the range of $360,000 to $750,000.”
On some level you know this information, but it is difficult to stick to it, especially as the stock market meanders at these lower levels. But with CDs earning a paltry few percent and inflation on the rise, the alternative does not seem appealing. Tomorrow we’ll tackle another great Consumer Reports Money Mistake.
According to the Consumer Reports “Money Lab”, the number one, costliest mistake that people make is investing too conservatively during retirement. I have seen this problem first-hand – as people retire, they abandon riskier assets like stocks and allocate much of their portfolio in bonds or cash. I always try to explain that for most people, this decision can be problematic. The reason is that the number one goal of retirement portfolio allocation is to keep pace and hopefully beat inflation. To do this, you probably need a broadly-diversified portfolio, which means that you can not abandon risk all together.
Conventional wisdom has long suggested that as retirees age, they should shift money out of stocks and into more stable investments, such as bonds or certificates of deposit (CDs). But the problem with that philosophy is that those safer instruments’ annual returns may barely keep pace with inflation, while stocks, over time, typically provide returns significantly above inflation. And inflation can be a retiree's worst enemy.Consumer Reports teamed up with investment-research firm Ibbotson Associates, to back test the idea of a diversified portfolio using data from 1940 through 2006. In the exercise, they assumed that the investor retired at 65 with $500,000 in savings to invest. They also factored in that the retiree would need to pull some money out of the portfolio at a rate of 3 percent each year during retirement and adjusted returns for inflation. The results were impressive: “we found that an asset mix leaning more toward Standard & Poor's 500 stock index than bonds provided bigger returns and annual cash draws…the team estimates that the cost of this mistake to people who are risk-averse to be in the range of $360,000 to $750,000.”
On some level you know this information, but it is difficult to stick to it, especially as the stock market meanders at these lower levels. But with CDs earning a paltry few percent and inflation on the rise, the alternative does not seem appealing. Tomorrow we’ll tackle another great Consumer Reports Money Mistake.
Wednesday, March 12, 2008
Aunt Fannie and Uncle Freddie
You may have noticed that two previously-sleepy companies have been in the news. The mammoth mortgage lenders Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) have come under severe pressure from the housing crisis. This prompted someone to ask me, “What’s up with Fannie and Freddie—I thought they were supposed to be safe!”
Before I go into the why, a brief overview of the companies is necessary. Fannie and Freddie are Government Sponsored Enterprises (GSEs), a group of corporations created by Congress that are intended to enhance the flow of credit to the housing market by maintaining an active secondary market for mortgages. Fannie and Freddie are publicly traded and are authorized to make loans and loan guarantees. However, they are not government agencies and Uncle Sam does not guarantee them. Although they are not directly backed by the full faith and credit of the US, GSE bonds have long been considered to be high credit quality and investors have assumed the government would bail them out in a crisis.
With Fannie’s stock down from over $70 in August to a low of $19.81 just a few days ago and Freddie’s from over $68 to a recent low of $17.52, some might say that the crisis is here. The stocks dropped over the past week as forced sales of securities by some distressed investors drove the yields on mortgage securities guaranteed by Fannie and Freddie to as much as about 3.5% Treasury securities, the highest since 1986. But over the course of the past year, Fannie and Freddie have been slammed as a result of the housing recession and anxieties that home-mortgage defaults will force the companies to raise more capital.
This may seem crazy, because GSEs mostly guarantee prime fixed-rate mortgages, not the more exotic subprime stuff. But even good borrowers have come under pressure as the housing market has continued to reel and the economy cools. Fannie says about 1% of the conventional single-family loans it owns or guarantees are 90 days or more overdue and that it expects credit, or default-related, losses equal to 0.11% to 0.15% of its mortgage portfolio this year, up from a previous forecast of 0.08% to 0.10%. Yes, these are teeny numbers, but considering that at the end of 2007, Fannie had guaranteed $2.55 trillion of mortgages, small numbers add up. Based on Fannie's estimate of 0.15% of losses, the total would be approximately $4 billion.
For this reason, the Federal Reserve stepped in yesterday to help. The US central bank said that it would lend up to $200 billion of Treasury securities and allow banks and dealers to pledge various flavors of mortgage-backed securities as collateral to help ease the strain on the credit market. That announcement helped Uncle Sam’s beleaguered cousins Aunt Fannie and Uncle Freddie tremendously, at least for the day, which judging by the reaction of investors (US stocks were up 3.5-4%), was necessary treatment.
Before I go into the why, a brief overview of the companies is necessary. Fannie and Freddie are Government Sponsored Enterprises (GSEs), a group of corporations created by Congress that are intended to enhance the flow of credit to the housing market by maintaining an active secondary market for mortgages. Fannie and Freddie are publicly traded and are authorized to make loans and loan guarantees. However, they are not government agencies and Uncle Sam does not guarantee them. Although they are not directly backed by the full faith and credit of the US, GSE bonds have long been considered to be high credit quality and investors have assumed the government would bail them out in a crisis.
With Fannie’s stock down from over $70 in August to a low of $19.81 just a few days ago and Freddie’s from over $68 to a recent low of $17.52, some might say that the crisis is here. The stocks dropped over the past week as forced sales of securities by some distressed investors drove the yields on mortgage securities guaranteed by Fannie and Freddie to as much as about 3.5% Treasury securities, the highest since 1986. But over the course of the past year, Fannie and Freddie have been slammed as a result of the housing recession and anxieties that home-mortgage defaults will force the companies to raise more capital.
This may seem crazy, because GSEs mostly guarantee prime fixed-rate mortgages, not the more exotic subprime stuff. But even good borrowers have come under pressure as the housing market has continued to reel and the economy cools. Fannie says about 1% of the conventional single-family loans it owns or guarantees are 90 days or more overdue and that it expects credit, or default-related, losses equal to 0.11% to 0.15% of its mortgage portfolio this year, up from a previous forecast of 0.08% to 0.10%. Yes, these are teeny numbers, but considering that at the end of 2007, Fannie had guaranteed $2.55 trillion of mortgages, small numbers add up. Based on Fannie's estimate of 0.15% of losses, the total would be approximately $4 billion.
For this reason, the Federal Reserve stepped in yesterday to help. The US central bank said that it would lend up to $200 billion of Treasury securities and allow banks and dealers to pledge various flavors of mortgage-backed securities as collateral to help ease the strain on the credit market. That announcement helped Uncle Sam’s beleaguered cousins Aunt Fannie and Uncle Freddie tremendously, at least for the day, which judging by the reaction of investors (US stocks were up 3.5-4%), was necessary treatment.
Tuesday, March 11, 2008
The Emperor Has No Clothes
I have run the gamut of emotions when it comes to NY Governor (and former NY Attorney General) Eliot Spitzer. I went from thinking that he was a tough guy who helped to expose some of the nasty underbelly of the financial services world, to thinking that he was an overzealous AG who went after his targets with venal and exaggerated accusations, hoping to squeeze large settlements. Throughout it all, Mr. Spitzer has remained sanctimonious and relished his reputation as the “Sherriff of Wall Street”. Yesterday the Sherriff was on the other side of the accusations, as it was revealed that he was involved in a prostitution ring, known as the Emperors Club VIP. Indeed, there was never a moment when the phrase “THE EMPEROR HAS NO CLOTHES” was more apt.
The New York Times reported earlier on Monday that Mr. Spitzer told senior administration officials that he was linked to a prostitution ring and from there the story emerged. The rumors were flying as federal prosecutors in Manhattan charged four people with organizing and managing an international prostitution ring. The charges refer to a "client-9" who, according to a person familiar with the situation, is Mr. Spitzer. At that point, the Governor had to speak, but only for a minute or so.
With his poor wife Silda by his side (how do these women do it? I wanted to kill him and he’s not even my husband!) and without referencing any specific behavior, Mr. Spitzer told reporters that he “acted in a way that violates my obligations to my family….I have disappointed and failed to live up to the standard I expected of myself…I must now dedicate some time to regain the trust of my family.” Here is what he did not do at that first news conference—he did not resign, which many expect will follow.
It is always amazing to see the mighty fall. After building a career with the 2002 analyst settlement; the 2003-04 mutual fund/late trading scandal; the 2005 AIG investigation and the multi-year Dick Grasso/NYSE executive pay fiasco, Time magazine named him “Crusader of the Year”. He was also the man who allegedly told John C. Whitehead, the former chairman of Goldman Sachs, “I will be coming after you. You will pay the price.” Now that Emperors Club VIP Client #9 appears to be Governor Spitzer, many will be coming after him and he himself will likely pay the price. Perhaps this is more than a salacious scandal, but a metaphor for the beginning of a pendulum swinging back to the middle where regulators view themselves more as truth-seekers rather than swashbuckling politicians aiming to intimidate those unlucky enough to be in their cross-hairs. Time will tell, but today it is indeed clear that Emperor Elliot has no clothes!
The New York Times reported earlier on Monday that Mr. Spitzer told senior administration officials that he was linked to a prostitution ring and from there the story emerged. The rumors were flying as federal prosecutors in Manhattan charged four people with organizing and managing an international prostitution ring. The charges refer to a "client-9" who, according to a person familiar with the situation, is Mr. Spitzer. At that point, the Governor had to speak, but only for a minute or so.
With his poor wife Silda by his side (how do these women do it? I wanted to kill him and he’s not even my husband!) and without referencing any specific behavior, Mr. Spitzer told reporters that he “acted in a way that violates my obligations to my family….I have disappointed and failed to live up to the standard I expected of myself…I must now dedicate some time to regain the trust of my family.” Here is what he did not do at that first news conference—he did not resign, which many expect will follow.
It is always amazing to see the mighty fall. After building a career with the 2002 analyst settlement; the 2003-04 mutual fund/late trading scandal; the 2005 AIG investigation and the multi-year Dick Grasso/NYSE executive pay fiasco, Time magazine named him “Crusader of the Year”. He was also the man who allegedly told John C. Whitehead, the former chairman of Goldman Sachs, “I will be coming after you. You will pay the price.” Now that Emperors Club VIP Client #9 appears to be Governor Spitzer, many will be coming after him and he himself will likely pay the price. Perhaps this is more than a salacious scandal, but a metaphor for the beginning of a pendulum swinging back to the middle where regulators view themselves more as truth-seekers rather than swashbuckling politicians aiming to intimidate those unlucky enough to be in their cross-hairs. Time will tell, but today it is indeed clear that Emperor Elliot has no clothes!
Monday, March 10, 2008
Beating the Market
We all know that it’s hard to beat the stock market, which is why an article in yesterday’s New York Times caught my attention. “Can You Beat the Market? It’s a $100 Billion Question” was the headline and its author Mark Hulbert points to a new study called “The Cost of Active Investing” by Dartmouth finance professor Kenneth R. French to figure it all out.
The French study estimates total investment costs, including “the fees and expenses of domestic equity mutual funds (both open- and closed-end, including exchange-traded funds), the investment management costs paid by institutions (both public and private), the fees paid to hedge funds, and the transactions costs paid by all traders (including commissions and bid-asked spreads)…French then deducted what domestic equity investors collectively would have paid if they instead had simply bought and held an index fund...the difference between those amounts…is what investors as a group pay to try to beat the market.”
Given this information, Hulbert concludes that “the best course for the average investor is to buy and hold an index fund for the long term. Even if you think you have compelling reasons to believe a particular trade could beat the market, the odds are still probably against you.” While this may be true in the abstract, I have to weigh in from real-life.
In my experience, this data and every study like it, assumes that people (a) want to assume the responsibility for managing their portfolios and even if they do want to be their own investment advisors (b) they can not resist tinkering with their strategies as market conditions change. To my first point, I think that people engage independent advisors not to beat the market, but to make sure that they entrust their future to a professional who will make unemotional decisions that are in their best interests. I liken this to my decision to hire sub-contractors to do work in my apartment: could I actually paint the walls myself? Of course I can, but I choose to pay someone else who I believe can do it as well or better than I can.
To the second point, I have found that many people who say that they will buy and hold just can’t do it. In fact, last week as stocks were making new lows, I heard from plenty of folks who said that they were “DONE”. I am fairly certain that what people mean when they say this is that they are done for now, but when the stock market starts rising, they will jump back in. While it may not be worth the costs to hire other folks to beat the market, it may be well worth it to protect you from yourself.
The French study estimates total investment costs, including “the fees and expenses of domestic equity mutual funds (both open- and closed-end, including exchange-traded funds), the investment management costs paid by institutions (both public and private), the fees paid to hedge funds, and the transactions costs paid by all traders (including commissions and bid-asked spreads)…French then deducted what domestic equity investors collectively would have paid if they instead had simply bought and held an index fund...the difference between those amounts…is what investors as a group pay to try to beat the market.”
Given this information, Hulbert concludes that “the best course for the average investor is to buy and hold an index fund for the long term. Even if you think you have compelling reasons to believe a particular trade could beat the market, the odds are still probably against you.” While this may be true in the abstract, I have to weigh in from real-life.
In my experience, this data and every study like it, assumes that people (a) want to assume the responsibility for managing their portfolios and even if they do want to be their own investment advisors (b) they can not resist tinkering with their strategies as market conditions change. To my first point, I think that people engage independent advisors not to beat the market, but to make sure that they entrust their future to a professional who will make unemotional decisions that are in their best interests. I liken this to my decision to hire sub-contractors to do work in my apartment: could I actually paint the walls myself? Of course I can, but I choose to pay someone else who I believe can do it as well or better than I can.
To the second point, I have found that many people who say that they will buy and hold just can’t do it. In fact, last week as stocks were making new lows, I heard from plenty of folks who said that they were “DONE”. I am fairly certain that what people mean when they say this is that they are done for now, but when the stock market starts rising, they will jump back in. While it may not be worth the costs to hire other folks to beat the market, it may be well worth it to protect you from yourself.
Subscribe to:
Posts (Atom)
