Thursday, July 06, 2006

Retirement Calculator

I came across a new "retirement calculator" from A.G. Edwards. (Read the press release) The scoring is based on the idea of credit scores, with ranks between 450-850. Anthing over 750 is considered excellent, 650-749 is good, 550-649 is fair and below 550 poor.

You answer 14 questions, including age, income, work years, home equity, savings and the like and it assesses the strength of your nest egg.

Your humble writer came in at 738, but mostly, I believe, because I do not own a home.

I like it because it compares you to other households, but my complaint is that unlike credit scoring, which have a predictive value (they tell a lender how likely you are to be late on a payment), A.G. Edwards offers no probability that you will reach retirement with x% of income. They also do not ask what your retirement goal is. Still it is worth checking out.

Monday, July 03, 2006

Retirement: How Much do you REALLY Need?

In my previous post, I noted that I believed that a sensible target for being able to retire (this applies even more if you want to retire early) is to plan to have significantly more income in retirement than when you are working. This enables one to have more "walking around money" to pay for leisure time activities. I have found further evidence of this at the end of the Retirement Report from the EBRI.

The report found that while most workers believe they can live on something like 60-80% of pre-retirement income (and assume that they can live well, since their retired parents appear to have far less income), more than half of retirees actually reported equal or greater income in retirement than when they were working. with one in five reporting higher income. Today's workers believe that they can have a retirement at least as comfortable as their parents, because a) they have earned more throughout their lives, b) they have a large home and c) their parents appear to do fine on low incomes. The problem with this logic is one of competition for services. Todays retirees compete with other low-income retirees for "retiree services". Many of their actual expenses (especially taxes and healthcare) are heavily subsidized by todays workers. Those subsidies may not be available tomorrow, and today's "high-income" workers will find that they are competing for services with other retirees with similar circumstances, so prices for those sevices will likely rise above present levels.

Finally, it is important to note that while today's retirees seem poor compared to their boomer children (at peak earnings), they find themselves in a lifestyle with which they were accustomed. Thus, their needs and wants are simply lower. Todays workers will find the experience far more jarring, and sadly, they may actually not have more income in retirement than their parents do today (while still facing higher prices). Unlike their parents, who won all sorts of subsidies to keep themselves in their houses, todays workers may find that they need to sell their house just to provide income for basic necessities in retirement (thus eviscerating the value of the tax subsidy for which they would otherwise be eligible).

This is why my personal monthly investing cashflow target includes a cushion that significantly exceeds my current net income (not to mention my expenses, which are at this time a fraction of my net income). I have built this cushion into my model to allow for three things. The first is inflation. It will take some time (at my current pace at least) to build this passive income and I want to protect my purchasing power. Second, I want to have walking around money. What is the fun of being a full-time investor, if you can't take advantage of opportunities to use the time-flexibility that investing offers. Third, and most important, I want to ensure that I have streams of income to serve as further capital to make investments.

Indeed, if you are fortunate enough to be able to retire in your mid-50s (or younger), you should plan to expand your capital base. The reason for this is simple. You will need to plan for a rising income in retirement to keep up with inflation (or even better, wages). There are two ways to do so, either you increase the returns on capital invested, or increase the amount of capital invested. Unless you can assume higher risk of loss in retirement than when you were working (unlikely for most people), you had better assume lower returns on capital, and lots more of it.

I am curious to know how others are preparing for retirement. What strategies are you using? How prepared are you?

Saturday, July 01, 2006

Retirement Crisis

This blog is about investing strategy, but it is important to realize that strategies support goals. One of the most important for everyone (including your humble writer) is retirement. While I have noted that my goals have changed from a retirement-centered net worth model to a cashflow-centered investment model, my strategy involves a plan to be able to retire, even if I fail to meet my primary investing objectives.

It is therefore saddening to read in todays Wall Street Journal that the Employee Benefit Research Institute has found that most Boomers believe that they are well prepared for retirement, and yet, have failed to save for it. Most workers are literally planning to be poor in retirement, which I consider to be a very bad strategy indeed.

Before we dig a bit deeper into the findings of the report, I want to note that I believe the only intelligent strategy for retirement planning is to expect to need MORE MONEY in retirement than you need when you are working. I realize that my target it iconclastic, and contradicts conventional retirement planning wisdom. The conventional wisdom is simply unwise.

Here's why: free time is expensive. I went to the barber this morning, and in the course of the normal bullshitting that goes on, I asked if they were going to take Monday off to make a three day weekend out of it (in Bergen County, New Jersey, blue laws prohibit most businesses from being open on Sundays, and Tuesday is the 4th of July). He mentioned that, no, it was a normal week, apart from Tuesday the Fourth. Then, sagely, he remarked, "If we had the day off, I'd just spend money. You know, you do a few things, and you ask yourself, where did it all go?" This is exactly the problem. If you are the ueber-achiever that I suspect most readers of this blog are, you currently work something north of 45-48 hours a week (plus commuting time). What will you do when you are no longer working? No doubt, you will volunteer or find other "low-cost" activities like blogging to fill your time, but how many of us also want to travel, have a second home play golf at nice courses and/or own a boat? (Personally, I find that you can either sail, or golf, but not both there simply isn't enough time. Maybe, in retirement I will find a way).

The secret of retirement is, free time is expensive. Since so many of us are reaching retirement healthier than former generations, we will want to do more active things, not spend time playing bocce in retirement communities and sitting by the pool complaining about Medicare (though I suspect that many will do so).

Of course, you could always work. In fact, the concept of retirement is really a relatively new creation. Before Bismarck created state pensions in Germany in the 1880s, almost no one retired. According to the study, many people (67% of workers, actually) expect to work in retirement. This will help to mitigate the expensive free-time problem and it will provide some income, but most of the jobs that people expect to do will not replace their peak earning incomes.
And any Boomer who falls ill will likely run through their meagre savings quickly, since they do not have the same retirement benefits offered to those born before 1940.

Since most people are failing to meet even the insufficient standards of preparation suggested by the retirement planning industry, as investors, we need to consider how we can protect ourselves (and profit) from Boomer financial folly. Make no mistake, since profligate Boomer spending has been a major driver of economic activity in the US and the world, when it comes time to pay the piper, Boomer spending habits will cause significant upheaval in the markets.

So what does the report actually suggest? You can read it in its entirety here. The survey was of 1252 American adults over 25 (1000 workers and 252 retirees) in 21-minute telephone interviews.

The scariest finding is that 30% of people saving nothing for retirement and that of those, 44% of believed that they would have a comfortable retirement, because of money from employers, inheritance and "faith".

Even though only 40% of people had a defined-benefit (traditional pension) plan 61% expected to receive benefits from one!

More than half had saved less than $50,000 for retirement. It should be noted that the youngest workers cannot be expected to have saved large amounts, and the oldest workers are likely to have additional income from a traditional pension. Current retirees have about 3x their salaries in savings when they retire. Still, what does it say about people's spending habits that they have essentially saved NOTHING? How can they expect to live on much less than their salary, when they are consuming all of it today? Remember, free time is expensive! Even traditional retirement formulas that assume a good target is 80% of pre-retirement income begin with the presumption that much of that 20% differential represents pre-retirement savings. That is, just before retirement, you are already living on only 80% of your income, because of savings. Once you retire, you can stop saving, so you essentially have the same standard of living in retirement that you had just before it.

Finally, 42% of workers have not made even an estimate of their needs in retirement, so it is no surprise that they are confident and unprepared. 22% of very confident people are not currnetly saving for retirement, 39% have less than $50,000 saved, and 37% have made no estimate of how much they need. Ignorance is bliss, but like faith, it is not a good retirement strategy.

So, what can you do to protect yourself and profit from this coming generational debacle? Well this writer fully expects a major asset-price collapse, a collapse that will be compounded by an effort among central banks to deflate the asset bubble their easy money has created.

You must protect capital in stable-value, even insured, products. In a demand driven deflation like the 1930s, cash is king.

If you are nearing retirement, consider (even with seemingly low interest rates) putting some of your nest egg into a single premium immediate annuity, which will guarantee income for life. Do this with a highly rated insurer, as weaker insurers will likely default in an asset-price crash.

Reconsider your equity investments carefully. In a major economic downturn, consumer staples will hold up best. Make sure that the companies whose stocks you purchase are not highly leveraged, as falling prices will make it dificult to generate sufficient cash flows for debt service. Count your dividends. These are real returns, and retirees will need the dividend income, so such stocks will be the least hard hit.

Think high taxes. As government revenues fall, making a bad fiscal picture absolutely terrifying, governments will look to raise taxes everywhere, but especially on incomes and businesses (though, in an effort to placate angry, near-destitute retirees (voters), they will likely continue to keep them low on investment income). Think about ways to generate income from investments.

Consider international investments in countries with better demographics and favorable economic conditions. Note: China does NOT have favorable demographics and will be very hard hit in a major downturn as outlined above.

Sorry for the gloom and doom. I am really an optimistic person (I guess I count myself among the "very confident" crowd). But whenever I see numbers like these, I am truly dismayed. I believe that the Boomers are fomenting an economic boom and crisis much like that of the 1920s and 1930s, when the last "idealist" generation - that of Hoover and FDR - hit retirement. Already we are seeing Smoot-Hawley tariff style protectionism. A collapse in global trade, forcing consumer prices up, together with a collapse in asset prices, driving purchasing power down, is a recepie for disaster.