Stunning 2010 Census Findings

For those of you who missed the recently published 2010 US Census findings, I suggest you read this recent article by the NYT. These days, I see too many “mean” metrics and not enough “median” metrics. Well here’s one I cannot get over: the US median income for a full-time male worker in 2010, about $47,700, is lower in real terms than in 1973. No, no typo, 1973. I still can’t get over it. All those productivity gains, all our great technology…is anything trickling down?

Finally, An Adult Speaks About the Facts

David Stockman again hits the nail on the head with his “cut through the doctrinarian crap” editorial in the NY Times about the budget impasse in Washington. Yes, the David Stockman who headed the OMB under Reagan, a Republican President. He cogently points out the cynical aspects of Paul Ryan’s budget proposal which is essentially a great big transfer from the poor to the richest 1% that already control more than 35% of America’s wealth without balancing the budget. He also targets some of the faults in the Obama plan.

So let me get this straight – Paul Ryan wants to give health care vouchers to the poor and hopes they won’t visit a hospital which would result in a substantially higher cost of care? So let me get this straight – let’s cry for the 1% that controlled 21% of America’s wealth in 1979 that now control 35% because they have to pay more capital gains taxes? And the solution – the middle class should sock-it-to the poor, not the rich, that controls nothing? There is no doubt that the US middle class is suffering – but is this suffering caused by the 40 million under-privileged in America?

This is not about class-warfare – this is just about the facts and about the kind of society we want to be. Are we really ready to disband the New Deal and the Great Society? Are angry people directing their anger in the right place?

Beware the Ape Man

The Sunday Times included an excellent article on the perils of conventional approaches to retirement planning. All of us responsible adults postpone consumption and save to finance the days when our earnings in the work force will decline and eventually end (yes, retirement).

Be aware that the conventional approach of most financial advisors fails to transition people responsibly from the accumulation life-stage to the retired life-stage. One of the causes is a conflict of interest in the financial advisor’s business model since the right transition and de-cumulation approach results in “dead assets” because the advisor cannot earn a high commission or fee. If you were 58 in 2004 with a large allocation to equities and you hoped to retire by 65 in 2011, because the equity markets would return 8-10% annually, you very likely lost a bet that you may not have realized you were making. The result may be outliving your savings by 5-10 years more than anticipated.

Anybody in their late 40s or early 50s must begin to build a solid, risk-free floor to cover their expected future consumption liabilities now. This means calculating what these liabilities are and slowly shifting your savings into assets that you can count on in the years of your retirement. Anything left over can be exposed to riskier asset classes with higher expected returns to finance a better lifestyle.

The Problem with Financial Education and Literacy

I’m going to start this post with a quote:

“Anyway, I keep picturing all these little kids playing some game in this big field of rye and all. Thousands of little kids, and nobody’s around – nobody big, I mean – except me. And I’m standing on the edge of some crazy cliff. What I have to do, I have to catch everybody if they start to go over the cliff – I mean if they’re running and they don’t look where they’re going I have to come out from somewhere and catch them. That’s all I do all day. I’d just be the catcher in the rye and all. I know it’s crazy, but that’s the only thing I’d really like to be.” ~J.D. Salinger, The Catcher in the Rye, Chapter 22, spoken by the character Holden Caulfield

What Holden expresses above in many ways mirrors how I feel about the financial state of American families. I attended a retirement income conference this week and listened to many experts present their perspective on the retirement challenge for the baby-boom generation. Top on the agenda was educating investors through work place efforts in conjunction with defined contribution programs. As I listened to discussions about what the Department of Labor would do about mandating retirement income as a qualified default investment alternative (QDIA) and helping households gain more financial literacy, I just couldn’t stop thinking about all those messages that financial service companies send to consumers and just how confusing it is to figure out how to manage our budgets and our investments.

More thoughts this weekend on this.

Toilets, Ostriches and Inconvenient Truths

For anybody interested and wondering what caused the US economy to fall into the toilet, I strongly suggest spending 15 minutes to read this op ed written by David Stockman, Director of the OMB under Reagan. Culture, policy, and not just a few rogue traders. Then let’s ask ourselves the following question – if the US public and politicians were an animal, what would it we be?

The Right Way to Develop a Retirement Portfolio

As I continue my education in personal financial planning and advice, I hope to share insights that I believe will be valuable to people in my network. I’m in the process of reading Michael Zwecher’s relatively new book, Retirement Portfolios, and I’d like to share some of his sage advice.

Now, most of you will say “I’m too young to be thinking about financing retirement”. Well, if you read this book, you will be convinced that the sooner you begin to plan how to meet your retirement consumption liabilities, the better off you will be. And it’s not just about saving more (although savings is a big piece of the puzzle).

Zwecher’s premise is that most people are pursuing an investment strategy of “hopeful accumulation” which is way too uncertain. You know what most of the more enlightened financial advisers say: diversify across a broad set of asset classes with low correlations in a tax efficient manner. Simple as that. So allocate 60% to equities, 30% to fixed income, and 10% to cash, and more than likely, things will work out and maybe you’ll build great wealth. Or maybe not.

Hmm, well that makes sense, right? Well, if you’re an ultra-high net worth household, it might. But if you’re like the other 99.5%, it does not really make sense. Why? Because you will have basic consumption needs that must be financed as long as you live. You need guaranteed sources of income – not 62% or 90% probable.

As individuals, we spend so much time researching the products we invest in and so little time thinking about the best way to secure a good lifestyle for the rest of our lives. So here are a few tidbits of advice that come from Michael Zwecher and that I think make a whole lot of sense:

1) It starts with building a floor. That’s right, understanding your consumption needs for the rest of your life, particularly when you stop working (if you can). The basics, nothing extravagant. You need to lock up that floor of guaranteed income as soon as possible and you can begin as early as your 30s or 40s. The earlier, the cheaper the cost of the floor. You lock it up by building a flooring portfolio that delivers the guaranteed income when you need it.

2) You can build a floor with capital market products, insurance products, or a hybrid. And social security and pensions count too. Insurance products are highly efficient because you benefit from mortality credits – you know, those who live long get the money of the people why die young; but you lose a lot of control because you make a lump sum payment to an insurance company (note that there is some carrier risk and it may be best to diversify). Think strips, zero-coupon bonds, TIPS, fixed and variable annuities, longevity risk insurance. The choice between insurance and capital market products is an important decision that is best made early.

3) Once you build a floor, build a cushion just in case things go wrong. Not a big cushion – just a layer between your floor and your upside portfolio layer.

4) Then build an accumulation portfolio, your upside layer, which now can be structured in a more aggressive manner because you have a floor that protects you, potentially leading to great upside because you can now take more risk.

5) Remember, once you build your floor, most of your worries about financing your retirement will disappear. After that, it’s all down hill.

That’s all for now.

Trauma on a Bicycle, the Ascent of Money, and the Financial Crisis

While convalescing after a traumatic bicycle accident that resulted in a broken face, nose, hand, etc, I read Niall Ferguson’s Ascent of Money. Going back to the glorious age of Mesopotamia and concluding with an updated analysis on the current financial crisis, the book’s historical perspective instills both confidence in the long-run resilience of the global financial system and pessimism for the viability of the current financial paradigm. In other words, the core concepts of the financial system will endure e.g. people will borrow, companies will borrow, people will lend etc; however, the system will experience important structural and relational transformations that will render certain people and entities obsolete while new entities will emerge, better able to meet the needs of the real economy.

Call it survival of the fittest and a form of financial Darwinism. For example, expect hedge funds as an industry to shrink, a bias toward allocating large shares of wealth to real estate to be reassessed, and the West’s relationship with China to be strained from what has been an unhealthy, imbalanced, unsustainable relationship for the last 10-15 years. Anybody understand the link between the housing crisis and the Chinese government’s struggle to maintain legitimacy after changing development models in the 1980s? Between rural/urban migration, job creation pressures, corporate profits, currency management, easy credit, and the home price inflation? Anybody wonder why China is “locking up” sources of energy, natural resources, and commodities? Will this create a “clash” in the future? Is conventional war between nations really obsolete?

The debate and the execution of global economic policies in the next 12-18 months will impact both the pace and the pain of these changes. The deficit hawks e.g. Trichet, Merkel will accelerate the speed of change and cause more short- and medium- term pain while the more welfare oriented defenders e.g.Krugman will have the opposite effect.

More thoughts when my left arm cast is removed in two weeks. I believe this financial crisis is far from over and that the financial system will change for the better. Forget about who moved your cheese – time to change your diet. Accept and embrace change – or be left behind. You may even lower your bad cholesterol.

More to come…

I can’t believe what people are saying…

I’ve been having conversations with two different audiences these days. The first audience is composed of people like you and me. The second is filled with professionals in the investment management and retirement services industry. I can’t believe what I’m hearing!

In the first audience…several of my financially savvy friends, witnessing the gradual decline in the value of their hard fought savings, now wish they had spent more and saved less. “those families spending all of their income on lavish vacations knew more than us fools saving for the future”. Ouch.

Many in the second group, the experienced financial professionals, are now admitting that the days of the pension probably made more sense than today’s self-directed investor system. After all, the great thing about a pension is those who die young finance those who live “too long”. This pooling concept makes so much sense, indeed! Can I believe my ears? I thought social security should be privatized and that we would all manage our assets like Goldman Sachs geniuses to the moon and live a great retirement?

How can conventional wisdom change so quickly?

Is Hopeful Accumulation A Currency?

Like it or not, almost all of us will pass through the pre-retirement and retirement life stages. For most of us, the pre-retirement stage probably starts sometime in our fifties and the retirement stage starts in our 60s and continues until we…well, no longer need to worry about paying for our consumption of goods and services.

If there’s one thing the last 20 years have taught us, financial markets are volatile, unpredictable, and can be dangerous. Depending upon when you begin to withdraw your savings in retirement, you may or may not run out of money. Many households entering retirement in the past few years with excessive equity allocations will find themselves under-financed and their financial plan (if they had one) obsolete. This approach to financing retirement is the hopeful accumulation model. Remember, running out of money is not an option, especially at his stage in a person’s life.

Depending upon your net worth and your consumption needs, the hopeful accumulation model has some merits and should be part of a household’s plan if a stream of guaranteed income exists to finance a reasonable floor of consumption. However, you know that nobody will accept “hopeful accumulation” as a currency to purchase what you need to live when you’re in retirement.

I’ve spent some time recently studying the variable annuity market. Variable annuities generally have a bad reputation – they’re complex and often very expensive. But they can serve a very important role in a household’s retirement plan: the insurance company will send you a check every month – guaranteed – as long as you live. I spent three hours this week with someone at Met Life, and we had to call an annuity expert to get to the bottom of all of my questions, many of which my interlocutor had never been asked. Believe me, the questions I asked needed to be answered e.g. what’s the death benefit to my spouse if I take off early, for my kids, can I get low fee investment options etc. Annuities are complex, but the benefit is very straight forward – protected income for life. You’ll probably need an expert to help you make the best decision.

So here’s the deal with variable annuities: essentially, you write the insurance company a check to create an account, you pay about 2% per year in fees to have a guaranteed 5-6% return per year (that’s the floor, will be higher if your portfolio’s return is higher) until you elect to start to receive payments (thereafter, the guarantee disappears but the upside still exists), you allocate your assets using a fairly open platform of investment options (with some constraints on equity allocation, and in some cases, some pricey options – look for indexes), and sometime in your 60s or even later, you elect to begin to receive a monthly check of 5% times the value you’ve accumulated up to that point. And the check keeps coming until you’re…well…no longer in need of the check. I don’t remember the exact term, but essentially people who live a long life benefit from the payments of people who live a short life. This is the nature of pooling risk and why the insurance company can make money offering this service/product. Oh, and you can withdraw your account, although the penalties for this vary.

But remember, the point of an annuity is to avoid a situation where you outlive your assets and cannot afford to consume. An annuity creates some protection by guaranteeing an income. With so few people able to count on a pension and wondering how to address the unpredictability of the markets, a variable annuity should be considered as a potential element of a smart retirement plan.

Your Advisor: Sales or Fiduciary?

The wheels of public policy are spinning in Washington DC as the Department of Labor, the SEC, and the Congress scramble to figure our how to cure the financially sick patient: the baby boomers streaming toward retirement who will live longer than any generation before them.

Conflicts of interest between asset management businesses and financial advisors continue to be an important theme. It is noteworthy that Fidelity Investments announced yesterday that the company was being reorganized into two separate businesses: distribution and asset management.

Okay, this may be boring stuff to you. But I have one question for you: what hat does your financial advisor wear: fiduciary or sales? If it’s the latter, be aware that they are not expected to put your interests before theirs. Only “suitability” matters. It’s like having a doctor more interested in his revenue than your health. Would that be okay?