Wednesday, May 17, 2017

It's Your Nest Egg

Something is happening out there. When I see an unusual editorial position in the financial press twice in two days from two different sources, I have to ask, “Why?” I don’t have an answer to that question, but I do want to bring it to your attention.

For those of you who are new to the blog, let me tell you about the 4% rule, an almost universally accepted method of spending down your nest egg in retirement.

Here is how it works. Add up all your savings and investments. Multiply that number by 4% for the first year of retirement. Then adjust it for inflation every year thereafter. If your nest egg consists of 50% bonds and 50% stocks, there is a 98% chance you will not outlive your money, assuming that you live for 30 years after the date of your retirement.

Example: You have a total of $1,000,000 in your 401(k), Roth IRA, bank accounts, and taxable brokerage account.

In the first year of retirement, you can withdraw and spend $1,000,000 X 0.04 which equals $40,000.

Let’s say inflation for that year was 3%. That means in year two you can withdraw $40,000 X 1.03 which equals $41,200.

This calculation, backed by numerous peer reviewed studies, approaches an article of religious faith in the personal finance community.

Yet yesterday, Bloomberg reports that “Rich Retirees are Hoarding Cash out of Fear.”

Well, since I no longer have a job to replace any savings I spend on an E Class Mercedes or lose in a market crash, I would think I need to be a bit cautious. If the market continues to go up as I grow older, obviously I will have more money to spend in less time, but what if the market goes down as fast as the cost of living increases? Then what? This is exactly what happened in the 1970s.

The author, Ben Steveman, tries to make the case that the money the Baby Boom saved for retirement is somehow preventing younger Americans from saving any money.

Huh?

He goes on to encourage me to buy a second home and an expensive car. I do plan on buying a reasonably expensive car when it is time to retire my 2010 Acura TSX, but given the way I buy a car, that isn’t going to happen anytime soon. He believes that after a lifetime of thrift, someone needs to train me how to spend more on luxuries. He would be happy to learn that my wife and I are planning a Mediterranean cruise, but how that is going to put more money in the retirement accounts of the thirty somethings is beyond my comprehension.

For today’s entertainment Charles Schwab offers an article entitled “Beyond the 4% Rule: How Much Can You Safely Spend in Retirement” by Cooper Howard and Rob Williams. The authors go through all the assumptions that underlie the 4% rule that have been reported ad nauseam in this blog and innumerable other publications, assuring us they are just assumptions. What if your life doesn’t end up fitting the assumptions? Then what? You could have taken more risk with your money.

Then your next car might be an S Class Mercedes instead of some trifling $60,000 midsized sedan.

The authors offer a tool to help you guess the date of your appointment with our Lord, in the hope that you can convince yourself to spend more money and take greater risks with your investments.

Check it out!

Actuaries Longevity Illustrator

The authors believe that a 98% confidence level is too high. They think a 75% to 90% confidence level is more appropriate. They conclude that, “75% provides a reasonable confidence level between overspending and underspending.”

If I come up snake eyes at age 85, will the authors support me at my then current spending level for the rest of my life, or will I become totally dependent on the taxes of those young people mentioned earlier in Bloomberg article?

Personally, I would prefer to underspend and leave the balance to my heirs and favorite charities rather than becoming a burden on society.

The questions remain, “Why would the financial press suddenly change direction after hectoring us Baby Boomers to save more money over the last two decades or more? What’s in it for them?”

If you are unfamiliar with the 4% Rule, the Schwab article does provide a pretty good introduction to the assumptions contained in this method of estimating a safe spending rate in retirement. While I think a 75% confidence level is way too low, their suggested allocations and withdrawal rate chart is really not all that out of line with my opinions.

Beyond the 4% Rule

Friday, April 28, 2017

Diversified? Yes or No?

In the April edition of a newsletter written by Mathew Young, the author brings up an interesting point about achieving diversification through the use of low cost index funds, as championed by proponents of Modern Portfolio Theory (MPT) such as John Bogle, founder of Vanguard funds. While this method is undoubtedly the best way for the average investor to put their retirement savings on automatic pilot, it contains hidden dangers.

In previous articles, I have discussed the criticisms of Benoit Mandelbrot and Nassim Taleb, who have pointed out that MPT makes the assumption that market performance can be described as a normal distribution when, in fact, the actual data produces thicker tails than are found in a Gaussian distribution. This means the market is a more dangerous place than explained by MPT.

From my understanding, the problem comes down to what data to include and what data to exclude. This question can cause violent disagreements between rational engineers. If all the other 200 data points on a graph lie along a nice straight line, what caused the one point that is way off by itself? If a sleepy junior engineer working the night shift forgot to take his zeroes before making a run, the point should be discarded, but if the cause is unknown, it might be an actual system instability that appears under rare conditions that we don’t understand. In this case, not only should the point be included, but additional testing will be recommended to the sponsoring organization.

When this question occurred in financial decision making, hedge fund programmers using accepted statistical methodology made assumptions that, while mathematically correct, made no sense outside of academia. While an occurrence can be calculated as a once in 2,000 year event based on 50 years of data, trusting this result with real money in the real world is just the kind of madness that led to the crash of 2008. This story is examined in exhaustive and exhausting detail in The Plight of the Fortune Tellers by Riccardo Rebonato, an outstanding though difficult read.

Young notes that many investors choose to buy shares in an S&P 500 index fund that mimics the value of the 500 largest corporations on the New York Stock Exchange or NASDAQ. Sounds good? Well, Young points out that market value weighting factors used in the S&P 500 put 22% of your money in technology stocks, one of the most unstable sectors in the economy. Also technology stocks are notorious for paying small dividends. Over the course of many years, you can expect about ½ of the growth of your investments to come from the compounding power of dividends. Do you really want 22% of your money in one sector that doesn’t pay a good dividend? Young points out that Apple accounts for 3.65% of the S&P 500, an amount equal to the 100 smallest constituents in the index.

Remember what happened in the Dotcom bust in 2000. Companies such as the FANG stocks (Facebook, Apple, Netflix, and Google) that went up very fast in 2015, can also come down just as fast. The average price earnings ratio for the S&P 500 over the last 130 odd years is 16. Currently the FANG stocks have a price earnings ratio of 61.

Even if you are buying mutual funds rather than shares in individual stocks, it is still worth your effort to know what you are buying. Normally a quick Internet search will list at least the top 10 positions in a mutual fund. For example Vanguard Wellington, (VWELX) a managed fund that I have purchased for my own portfolio, lists the top ten positions as Microsoft, JP Morgan Chase, Chevron, Intel Corp, Wells Fargo, Alphabet Inc, Bank of America, Comcast, Chubb, and Merck. If this was my only holding, I would be worried about an overexposure to money center banks.

Wellington, my TSP-C Fund, as well as my personal holdings, all feature Chevron.

So, “Am I diversified?” is not always an easy question to answer.

An example of the holdings of a Vanguard Target Fund appropriate for someone around the age of 40:

Vanguard Total Stock Market Index Fund Investor Shares51.9%
Vanguard Total International Stock Index Fund Investor Shares35.0%
Vanguard Total Bond Market II Index Fund Investor Shares9.2%
Vanguard Total International Bond Index Fund Investor Shares3.9%

Thursday, April 27, 2017

Qui Cum Canibus Concumbunt Cum Pulicibus Surgent

In attempting to help others find their own path to financial freedom, I was surprised to learn just how important the company you keep is to the outcome of your life. Are the people in your life inspiring you, encouraging you, pushing you in a better direction or are they holding you down, keeping you trapped in a place where they are comfortable?

Walking the Swamp Rabbit Trail I have met a lot of people, who like me, are attempting to become a healthier person through regular exercise. These three examples all happened in just the last couple of weeks. I was cheered on by three members of the Furman women’s track team. A man in his late twenties with a body of chiseled steel told me that he found my presence on the trail in all kinds of weather an inspiration. A middle aged woman training for a half marathon slowed down long enough to get to know me better and encourage to keep fighting the good fight.

There are times when I am inclined to believe that anything moving slower than me is probably a rock, but even this old man with his arthritic knees has had the opportunity to encourage other retirees who are just starting an exercise program or are walking to recover from surgery or some kind of physical malady.

Any time you make a serious effort to better your life, some of your companions will become uncomfortable. They will tell you all the reasons you shouldn’t try and all the reasons your efforts will surely fail. The truth is they don’t want you succeed, because if you do, they will feel inferior.

When I first became serious about investing for retirement, a number of people told me the game was rigged against the little guy. They told me I would lose all my money. The fact is they were unwilling to make the effort to learn how to transform their above average salaries into an above average net worth. Some of these people slowly faded out of my life. Over time I met coworkers who knew more than I knew about the stock market and I started reading books by the masters. I began to share what I was learning with others. The more experienced encouraged me while trying to steer me away from potential mistakes. Eventually, I found that some folks were seeking out my counsel in an attempt to get far enough up the learning curve to feel comfortable taking some calculated risks with their money.

Like losing weight, increasing net worth is hard work. I have lost about 40 pounds over the last four years, but that required a lot of hours spent hoofing it up and down the Swamp Rabbit Trail. The stretch run to retirement took me about 10 years of concentrated, focused effort, but in that time I increased my liquid (excluding my house) net worth by something in the neighborhood of 700%. During that time I was slammed by the crash of 2008, just like everyone else. The fact is that in good times and especially in bad times, I need the support, encouragement, and yes, even the occasional kick in the pants from others to keep on keeping on.

Look at the people in your life. If you need someone to help you move up, I firmly believe in the old Chinese adage, “When the student is ready, the teacher shall appear.” Then your hard work can become smart work. It won’t happen automatically, but a chance encounter here and there with the right person at the right time led me to a better life. I am nothing special. If it worked for me, it can work for you.

P.S. In this post I have focused on positive possibilities that can change your life for the better, but remember:
"He that lieth down with dogs shall rise up with fleas"
Source unknown

Monday, April 24, 2017

The TED Talk Test

The other day in a private conversation, I was annoyed to realize that I was enjoying retirement so much that, to be honest, I was unwilling to make the big investment of time and energy necessary to move this blog from a part time ministry to a full time commercial product. I am certainly more knowledgeable than when I started the Silver Eagle Experiment and my writing skills have improved over the last nine years. I don’t expect any change in those trends, but when will I ready to try and jump to another level? Leaping into the unknown is always pretty scary unless a hungry bear is getting close to your leg. I felt that way when I left the saw chain factory for engineering school.

I jumped and never looked back.

While considering this conundrum, I came up with an interesting thought experiment. Let’s say you are given the opportunity to present a TED Talk. If you spend much time on the Internet, you have probably listened to at least one of these lectures. TED started as a conference presenting 18 minute lectures by people with amazing, inspired new ideas in the fields of Technology, Entertainment, and Design to an audience of movers and shakers. The presenters were not only given an opportunity to share their life’s work, but also a chance to begin to build a network of well positioned patrons and allies who could provide fuel for their passions.

Here is the deal.

You will be given the opportunity to present an eighteen minute lecture on any subject you consider important to an audience of 200 or 300 men and women of your choosing. They could be venture capitalists with hundreds of millions of dollars looking to invest in new products or services. They could be the managers and owners of publishing houses or broadcasting companies looking for new books to publish, movie scripts to produce, or ideas for TV shows. They could be powerful politicians and the donors who fund their campaigns. Your choice, but you only get one shot at the big time.

There is another bonus if you are successful. The best TED talks get millions of hits on YouTube and other services. You will not only have instant name recognition, but your dream will be granted Internet legitimacy.

Eighteen minutes is somewhere between 2,500 and 3,000 words depending on how fast you talk. I don’t even know what I would say that would differentiate what I am trying to do from a hundred others, some household names who have sold books and courses in the hundreds of thousands and others, who are anonymous bloggers just like me. Let’s say that at some point I have the words. Then I would have to practice in private until I had the speech just about memorized. After that I would have to experiment with live audiences to perfect timing and delivery. If I had spent years learning the art of public speaking, it wouldn’t take as long, but it would still represent a major effort for anyone.

David didn’t hit Goliath with the first stone he ever placed in a sling. From having been a small boy who owned a sling, I expect that David’s major source of entertainment out in the sheep field was learning how to throw stones with that weapon. Unlike me, I expect he was also learning how to sing psalms and play the psaltery to avoid going mad with boredom. I could hurl a rock an enormous distance with my sling, but where it would land was anybody’s guess. A champion slinger could hit a target the size of Goliath’s head, at least most of the time. I saw this demonstrated on cable TV. I believe God put the rock between Goliath’s eyes, but I also believe that David’s skill is what landed that rock on the Giant’s head.

What would it take me or you to care about something so passionately that we would make the kind of effort it takes to jump whatever you are dreaming about to the next level? What kind of things would we do that others might find a bit crazy, because we cared so much we couldn’t help ourselves from trying just a little harder?

I heard a successful televangelist talk about the first days of his ministry. Once he rented a room and no one came to hear him speak. He went ahead and delivered his sermon to the empty room, in the belief that God had told him to do it and if no one else was listening, at least God heard it. I might question this man’s theology, but who can gainsay his determination?

Will I be ready to deliver my TED Talk when the opportunity presents itself? If I haven’t delivered it to a lot of empty rooms and at least 20 or so small audiences, I would expect the answer would be, “No.”

Sunday, April 23, 2017

Add Some Passion to Your Dream

Something rather unusual happened the other day. For the first time since I retired, I had the opportunity to throw some “new money” into the market.

Since I retired a little over four years ago, during most months we have lived on our renewable income and the mortgage payment we receive from the owner financed sale of our house in Maryland. In our case, renewable would be my wife’s early Social Security and my FERS pension. This has been enough to cover everything but extraordinary expenses such as repairs to the old house before the sale, the cost of moving to the new house, certain large tax bills, and that first-class vacation to Hawaii. On those occasions we dipped into our savings. After all, that is why we saved for retirement.

As an aside, let me add that when and how to take Social Security is a rather complicated question that requires an individual analysis before rolling the dice. First of all, you will have to guess how long you will live. If you take early Social Security at age 62 and die before roughly age 78, you win. If you wait until full retirement age, in my case 66, and die before 78, you lose. If you can wait until age 70, you can collect your maximum benefit. If you have longevity in your family, you might want to wait.

Or not!

The rules change all the time. In our case, we were able to flip my wife’s individual benefit to a higher spousal benefit at the time I started my Social Security at full retirement age. I had planned this maneuver with the understanding the rules might change before I reached 66. Then there is the question of necessity. If you are 62 and are unemployed, you might want to go ahead and take Social Security even if you believe you will live to 90.

After receiving my first three Social Security payments, I realized that my checkbook balance was higher than expected, as we were still living on renewable income and that monthly mortgage check. For the first time in more than four years, I had some new money. It reminded me of the years spent in the stretch run to retirement. I wanted to retire at the earliest possible date. Baring a winning lottery ticket, that would be the day after my 62nd birthday, the first day I could retire without a pension penalty. I remember how exciting it was to watch my version of a 401(k) growing with every paycheck. I was even more passionate about my self directed, after tax investments. When the balance went up in the checkbook, I would move some of that money up to our money market fund. I would tell myself stories about money that only moved in one direction—up, first from checkbook to savings, then from savings to investments in the stock market. This was almost always true except when we needed to buy a new car. Then money would move down from savings into the checkbook and off to the car dealer.

I was emotionally involved in my dream. I wanted to achieve my goal of early retirement so badly I could taste it. Think about times in your life when you were able to fuel a fantasy with your emotions. I expect this happened somewhere along the way to your wedding. It also happened to me when I was in engineering school. After nine years, I so wanted to get off the factory floor, that my academic efforts were fueled with passion.

Revisiting the memory of that feeling for even just a moment, as I purchased a small amount of a somewhat speculative stock, reminded me of how important passion can be in helping us to achieve our goals, but how to turn it on when we need it?

It seems like others are better able to hit our happy buttons for their benefit than we are able to tap into our emotional reserves for our own benefit. Last week I received a “private invitation” to experience a test drive in the new Alfa Romeo Giulia or Giulia Quadrifoglio, just the kind of car I would like to own some day. My wife had fun teasing me about this advertisement as she knows that although I am a logical researcher who reads Consumer Reports, a little passion will help in separating me from our money when visiting a car dealer.

If advertisers, marketers, politicians, and preachers know how to ignite a fire under our inertia, why can’t we learn to do it to ourselves? Tony Robbins correctly differentiates between the musts and shoulds in our lives. If it must get done, it will get done. Sometimes a should will get done, but often we find an excuse to avoid doing what we really know, in our hearts, SHOULD be done. The musts tend to be fueled with passion.

You Gotta Want It!

Saturday, April 22, 2017

Is It Working for You?

"In times of change learners inherit the earth; while the learned find themselves beautifully equipped to deal with a world that no longer exists."
Eric Hoffer

During their working years, the Baby Boom watched the covenant between workers and corporations that worked pretty well from 1945 until 1970 unravel. Besides oil shocks and the miseries of stagflation, we also experienced the deindustrialization of the United States that eliminated approximately 20 million good paying, relatively stable jobs with benefits for Americans of average ability. On the plus side we had a good run between the end of the recession in 1985 and the dotcom crash of 2000. The Internet and cell phone revolutions generated a lot of new wealth, unfortunately not as many new jobs, and we came to believe that the value of a house could only go up. We experienced a lot of change over the last 45 years. Much of it wasn’t good.

Unless our country changes direction, the future doesn’t look too hot for the Millennial Generation. Globalization, personal and public debt, and new jobs that require above average ability in technical areas that are in demand, entrepreneurial skills, or sales aren’t going to help someone with a high school diploma and no particular talent.

You’ve read the news. Too many Americans, including an unfathomable number in the top quintile are living paycheck to paycheck. Surveys indicate that 46% of households couldn’t cover a $400 emergency without borrowing the money. If it isn’t working for you, you had better become open to the idea of becoming a learner.

Get another degree, get a better job, worked for me, but I don’t expect that will work in the future, unless we are talking a M.D. Starting around 1973, our country started producing more college graduates than new jobs requiring a college diploma. Even in my case, my last degree really didn’t kick me to a higher pay grade than what I would have achieved without it. However, about the time I turned 50, I set out on a different kind of learning quest to discover the secrets of investment, so that I could retire comfortably some time before my death.

Given the rate of change in our economy, I don’t expect that I will be able to quit learning until I am dead or declared incompetent.

Your relationship with money isn’t exactly like your relationship with other humans, but the emotional indicators are remarkably similar.

If you are experiencing:

Fear
Anger
Hate
Blaming others
Guilt
Shame

Chances are you need to change direction.

If you are experiencing:

Peace
Joy
Love
Equanimity
Forgiveness
Generosity

Keep on doing what you are doing, but don’t miss the opportunity to explore new paths.

The basic facts of money, like the rules of chess are quite simple. However, learning to apply them with skill is the work of a lifetime. Studies indicate that chess is a game that is controlled, 100%, by the skills of the players involved. At the other end of the spectrum is the lottery, no skill, 100% “luck.” Good luck and bad luck tend to balance out over the course of a lifetime, just as the best teams in football tend to play in the Super Bowl, even though football (like investing) is maybe something like 20% luck.

Don’t be a victim. You can do this. The first steps are easy enough to learn. Go to the library. Dave Ramsey and Suze Orman are the big names, but the shelves are filled with introductory personal finance courses offered by authors from every social, religious, and cultural perspective imaginable. If you are a bit of a counter culture artistic kind of person, try “Your Money or Your Life by Joe Dominguez,” a classic. Be sure and get a recent edition, the investment advice found in the original has been seriously overtaken by events.

Money is just a tool, not an end in itself. The purpose of earning and saving more money is to make a better life for yourself, your family, your community, and your world. Your feelings, as well as your bank balance will let you know where you need to focus your efforts in learning how to improve your performance in this very important dimension of a balanced life.

Friday, April 7, 2017

Stories are Only Words--Unless You Believe Them

The “nuts and bolts” of personal finance are really pretty simple, requiring nothing more than third grade math and a copy of the golden rule. Don’t spend more than you earn. Put a little something in savings every time money crosses your palm. Try to cultivate a generous heart. If you want to earn more money, look for opportunities to be a greater blessing to your neighbor. Why then do so many people suffer from financial distress? I can sit down with someone and work through a monthly budget, but I can’t get them to believe that living on a budget or starting an emergency fund is a reasonable possibility. I have come to the conclusion that the stories we believe are ultimately what limit our chance to reach financial freedom, whatever that means to you.

Recently while listening to a lecture on finding financial freedom the teacher suggested, “Imagine looking into a mirror while saying, My greatest fear concerning money is…” The class dutifully repeated the first part of the assignment and then broke into self conscious nervous laughter. With a little more prompting, the braver members of the class shared their greatest fears. For me this was a spooky experience. As I said, “My greatest fear concerning money is,” I spontaneously visualized my parents standing behind me with their arms crossed and expressions of disapproval on their faces. My mother is dead. My father is suffering from Alzheimer’s. Sadly, I don’t think he even knows he has a son. Why is that story bubbling around in my subconscious mind, even though I am comfortably retired and write a Christian personal finance blog?

If the stories you tell yourself about money aren’t true and useful, you need to make an effort to find a better story. If the stories are both true and useful, hang on to them until you find something better. There is always a better story.

Consider an unemployed coal miner living somewhere in rural West Virginia: If he makes the statement, “The mine is closed. I will never find another job that will pay enough to support my family,” might prove to be a true statement if he remains in his home town, but is it a useful story? It gets worse. As we tell ourselves these stories over and over again, eventually we begin to identify with our stories. In this instance, this man might come to say, “I am an unemployed coal miner.” Identifying with our own story can become deadly. If I am a Type II Diabetes patient, a cure would destroy my self identity. Did you notice I said my father is suffering from Alzheimer’s? The disease is not my father. Your problem is not you.

Liberation is a possibility, but it will require a different story.

Richard Branson, founder of the Virgin Group wanted to be an entrepreneur from a very early age. He sees possibilities where I would see only problems. Once after his flight from Puerto Rico was canceled, Branson chartered a small airplane and sold tickets to his fellow passengers to cover the cost. I would have cursed my bad luck and tried to get seat on the next available plane. For Branson, this was the inspiration for Virgin America, a small but growing niche airline. Branson told himself a story about how easy it is to make money so many times that he came to believe it. His net worth is something like $4.5 billion, not too bad for a kid selling records at a discount price. This got him into legal hot water, because the price on some of those records was protected by marketing agreements that limited discount sales. Well, his headmaster correctly predicted that Branson, a poor student with learning disabilities, would either end up in prison or become a millionaire.

I have a friend who invests in rental properties. When he looks at a dilapidated little house requiring $20,000 in repairs and remodeling to make it habitable, he sees nothing but opportunity. He tells himself a story. The people who rent this house from me will not only pay the mortgage, but they will give me the house for free after they finish paying off the mortgage. I tell myself stories about broken toilets in the middle of the night and tenants who will throw parties for their biker boyfriends.

Same property.
Same cost and opportunity.
Different stories.

Go ahead. I challenge you to look into the mirror and say, “My greatest fear concerning money is…” Write down the answer. Then continue to write down the stories you tell yourself about money. Without judging or blaming yourself, examine the truth and utility of your stories. Are they based in scarcity, fear, anger, resentment, envy or greed? Chances are they will produce fruit that you won’t want to eat. If they are based in possibility, abundance, generosity, good-will, and happiness found in the success of others, your stories are likely to carry you a long way towards financial freedom.

Stories are only words and words can be changed.