If you were sick or disabled, who would drop everything they were doing to take care of you?

I recently wrote a sales letter for the agency about the need to plan for “extended” or long term care insurance.  When it comes to the issue of planning for extended care, many people experience a disconnect.  In sum, they believe they have nothing to fear because they think subconsciously, “It will never happen to me.”

The biggest risk from the dismissal of such planning is not so much about what happens to the sick or impaired individual. Rather, it is the fallout that occurs to those who are forced to step up to help the sick or impaired individual. And, who usually steps up? Those closest to us such as a spouse, a partner, a child, a lifelong friend. 

Below is the text from the marketing letter I wrote. I would love to hear your feedback. You can reach me through the comment section below or contact me directly, through this site’s contact page.

Here is the copy of the letter,

If you were sick or disabled, who would drop everything they were doing to take care of you?

If you could no longer care for yourself, who would be the first to make sure you received the care you need? Would it be your spouse? A partner? A sibling? A child? A lifelong friend?

Whoever it would be, it is someone who cares deeply about you. But, without a plan for the possibility of extended or “long term” care,  it is this person who may have the most to lose.

By starting a family, we invite people into our lives. Along with this invitation, comes a promise to provide for and keep our loved ones safe. Such promises last a lifetime, even into our elderly years.

The commitment to protect loved ones is human nature. It stems from a core belief that we can rise to meet life’s challenges with confidence. However, if we dismiss the need to plan by thinking “It will never happen to me”, we leave our promises to chance. Those we once said would take care of, may face the burden of taking care of us.

If we ever really needed help, certain of our loved ones would likely do whatever it takes to get us the care we need. Some would overcome any obstacle, make any sacrifice, and even put their lives on hold.

But, at what cost?

As a long-term illness or impairment progresses, higher and higher levels of care are required. If you have a surviving spouse, the burden for care will generally first fall on his or her shoulders.

-Spouses faced with the increasing demands of providing care for a partner often suffer irreversible physical, emotional, and financial consequences.

-In families with multiple children – especially as the healthy spouse begins to waver under the weight of providing unending care – frequently one child ends up taking on most of the burden to assist the healthy parent.Over time, this imbalance can cause friction among siblings. This often leads to future resentment and division in families.

-Due to the 24/7 demand for care, the child of a parent in need may be left with no choice but to set aside his or her life. Thereby, impacting his or her career, relationship with spouse, relationships with children, involvement in the community, personal pursuits, and more.

-The enormous cost of providing extended care frequently demands a reallocation of retirement income and may force an intrusion into underlying retirement assets. Such intrusions can undermine the future financial stability of a surviving spouse, special needs child, legacy planning, or charitable giving.

-Advances in medicine now allow people with chronic conditions to live longer than ever. While generally good news, for those who have no option but to put aside their lives to provide care, this can prove a source of increasing stress.

It doesn’t have to be this way.

You can help protect the people you love by putting together a plan before care is needed. The goal of the plan should be threefold.

1) For as long as possible, allow you to gain access to the care you need at home with minimal physical, emotional, and financial impact on the people who care about you.

2) Instead of having family members provide care directly, empower family members to hire and coordinate professionals to provide your care.

3) Where suitable, seek to mitigate the cost of providing care through the leverage of long term care insurance. Plans may be available which provide essentially a ‘return of premium’ to heirs should you end up not needing care.

Every person’s situation is different and there is no one-sized plan that fits all. At McCarthy Stevenot Agency, Inc. we have been guiding businesses and individuals with insurance needs for over 25 years.

To learn more about how to create and fund a plan to protect the people you love from the risks associated with extended care, contact our agency at this link.

Here is wishing you the strength to stay the course and deliver fully on the promise to protect those who are the most important in your life!

Best,

 

Ted Stevenot
Partner
McCarthy Stevenot Agency, Inc.

209 Main St., Milford, OH 45150 | Phone: 513-891-9888 | Fax: 513-891-3088
ted@mccarthystevenot.com | www.mccarthystevenot.com

45.9% spend more after they retire

A key factor in determining whether you can afford to retire is estimating how much you will spend in retirement. Experts say most will likely spend less because they have fewer overall expenses as a result of not working.

But, not everyone spends less.

In a recent study from the Employee Benefit Research Institute, nearly half of those studied ended up spending more. Those who did increase spending weren’t just the well off, but were represented across all income levels.

A few highlights from the study,

  • Median household spending dropped in the first few years after retirement. The reduction was 5.5% from pre-retirement levels for the first two years and 12.5% in the third and fourth years. After the fourth year, reductions in spending leveled out.
  • While the average amount of spending fell, a large percentage of households experienced increases in spending after retirement. 45.9% of those studied spent more in the first two years after retiring.
  • Those that spent more were not exclusively affluent households, but were distributed similarly across all levels. Of those who spent more, 28% spent 120% more than their pre-retirement level. After six years, 23.4% of households were still spending more.
  • In the first two years after retirement, transportation spending slowed the most. Median spending on transportation reduced by 25.1%.
  • Median of households in the study had mortgage payments before retirement, but no mortgage after retirement.

View the original study at here.

I have a theory that, unfortunately, a large number of people, once they gain access to their 401(k) savings in retirement, will not have sufficient experience with disciplining and budgeting their spending habits. As such, many will blow through their retirement nest eggs before they realize what they have done.

It is important to give serious thought to how much you will spend in retirement and how you plan to derive reliable and lasting income from your nest egg funds. Given increasing lengths of retirement, rising healthcare costs, volatility in the markets, and the general tendency of people to overspend, running out of money in retirement is probably easier than you think.

I wrote a report to help people solve these problems that includes: an easy method for estimating how much retirement income you may need, a list of ways to reduce expenses in retirement, and information on how to secure guaranteed income so that, regardless of what the future may hold, you will never run of money in retirement.

Download a free copy of the report at this link.

What are your thoughts?

  • Are you surprised to learn that so many people actually increase their spending during retirement?
  • Are you surprised that those who do aren’t just the well-to-do?
  • What do you think of my theory that many people will unwittingly exhaust their savings because they spend too much?
  • Did you know you could secure guaranteed income so that you will always have a “paycheck” during retirement?

Get more income for the same money

I have been doing some writing recently about “pooled income” – an idea that has existed in various forms for over 2,000 years – and how this resource may prove to be one of the biggest salvations for the Baby Boomer generation.

I looked up some numbers today to run a quick comparison between various alternatives for generating income at current rates – money market deposits, long term treasuries, and an immediate life annuity.

For this comparison, I assumed a male age 65 with $500,000 to allocate.

Here is how the numbers came out,

  • Money Market. Money market rates today (4-25-16 / www.bankrate.com) were paying between 0.85% and 1.00%. Assuming a 1% return on a $500,000 allocation, yields an income of $5,000/year.
  • 30 Year Treasury Bonds. The  yield on 30 Year U.S. Treasuries today (4-25-16 / data.cnbc.com) was hovering around 2.72%. Assuming a 2.72% return on a $500,000 allocation, yields an income of $13,610/year.
  • Immediate Life Annuity. I visited the CNN Money Retirement Calculator and ran a $500,000 lump sum for a 65 year old male for an immediate life annuity in my area. The result came back an estimated $2,744 per month for an income of $32,928/year.

Yearly income $500,000 allocation

These numbers change practically by the minute, but the general conclusion is clear. The annuity far exceeds the income generating capacity of the other alternatives for the same allocated amount.

Why does the annuity yield so much more income?

Because it is a pooled income product.

Pooled income is the primary engine behind entities as commonplace as Social Security and defined benefit pension plans.  People with 401(k) plans only and no company pension to fall back on can benefit tremendously from learning more about the benefits of pooled income products.

To learn more about how pooled income products work, click here.

Get back what’s missing from your 401(k)

People often speak nostalgically of the prosperous retirement era that our parents once had and how those days are long gone. But, what made our parents so lucky compared to today?

The major difference between then and now was that many of our parents had employer-sponsored “defined benefit” pension plans.

  • Defined benefit pensions offer employees a “defined” or specified benefit in the form of lifetime income upon retirement, say 70% of a worker’s final salary payable for life.
  • 401(k) plans, by contrast, are merely deferred savings accounts. They guarantee no future income and there is no second party promising any future benefits.
  • Defined benefit plans function using “pooled income.” Pooled income is a centuries old concept and one the most cost-effective ways to provide lifetime income to retired populations (learn more).
  • 401(k) plans make no use of pooled income. Instead, they presume people will amass enough wealth, generally through stock market investing, to live indefinitely off the earnings and appreciated value of their savings.

In comparison to what our parents had, the new retirement reality is a much more complicated and risky proposition – with more dependence on volatile markets, higher costs for management, greater personal uncertainty, and fewer guarantees.

But, it doesn’t have to be this way.

Get back what’s missing from your 401(k)

People can improve the outlook for their retirements by replacing what’s missing from the 401(k) retirement model. The key is gaining more access to pooled income.

There are many types of pooled income products available today that allow individuals to essentially create their own “private pensions.” In general, these products provide,

  • More retirement income per dollar allocated than other comparable options.
  • Guaranteed income for life and options for survivor benefits.
  • Protection against the risk of living too long and outliving retirement funds.
  • Insulation from the ups and downs in the market.
  • Simplified means of translating retirement savings into steady, reliable income.

Though the times have changed from the era of our parents, with greater access to pooled income options, the promise of a secure and enjoyable retirement remains within reach.

Click here to learn more about currently available pooled income options and see a simple way to calculate how much income you will need in retirement.

What do you think?

  • Did you ever wonder what happened to employer pension plans and why?
  • Does it surprise you to learn that pooled income can actually be less costly and more secure as a means of generating retirement income?
  • Did your parents or grandparents have pension plans that they benefitted from?

If you would like to discuss the suitability of income alternatives for your situation, you are welcome to contact me by email or through my Cincinnati, OH insurance agency, McCarthy Stevenot Agency, Inc.

Are you nervous about relying on the stock market?

Many people who lived through the 2008/2009 stock market bubble are still very nervous about the future of the stock market. Many are especially nervous about relying on the market as a means of reliable support during their retirement years.

As well they should be.

Most people aren’t aware that there are alternatives to Wall Street when it comes to achieving income security during retirement.

I have been doing some writing recently about “pooled income” – an idea that has existed in various forms for over 2,000 years – and how this resource may prove to be one of the biggest salvations for the Baby Boomer generation.

I looked up some numbers today to run a quick comparison between various alternatives for generating income at current rates – money market deposits, long term treasuries, and an immediate life annuity.

For this comparison, I assumed a male age 65 with $500,000 to allocate.

Here is how the numbers came out,

  • Money Market. Money market rates today (4-25-16 / www.bankrate.com) were paying between 0.85% and 1.00%. Assuming a 1% return on a $500,000 allocation, yields an income of $5,000/year.
  • 30 Year Treasury Bonds. The  yield on 30 Year U.S. Treasuries today (4-25-16 / data.cnbc.com) was hovering around 2.72%. Assuming a 2.72% return on a $500,000 allocation, yields an income of $13,610/year.
  • Immediate Life Annuity. I visited the CNN Money Retirement Calculator and ran a $500,000 lump sum for a 65 year old male for an immediate life annuity in my area. The result came back an estimated $2,744 per month for an income of $32,928/year.

Yearly income $500,000 allocation

These numbers change practically by the minute, but the general conclusion is clear. The annuity far exceeds the income generating capacity of the other alternatives for the same allocated amount.

Why does the annuity yield so much more income?

Because it is a pooled income product. Pooled income is the primary engine behind entities as commonplace as Social Security and defined benefit pension plans.

To learn more about how pooled income products work, click here.

Baby Boomers throughout their lifetimes have been barraged by the financial industry and the media that the stock market as the be-all and end-all for achieving retirement security, but there are other alternatives.

Click here for an easy way to calculate the income amount you may need in retirement and to learn more about how to generate that income.

To learn more about or discuss the suitability of various income alternatives for your situation, you are welcome to contact me by email or through my Cincinnati, OH insurance agency, McCarthy Stevenot Agency, Inc.

So, what do you think?

  • Are you worried about the markets and how they may affect your financial security in retirement?
  • Have the past few bubbles and bursts impacted your faith in the market?
  • Do you think the market is likely to become more or less reliable in the coming years?
  • Are you surprised at the difference in income amounts in the comparison above?

Pooled Income: The secret to getting more out of your retirement savings

One of the hardest things for people to do in retirement is translate nest-egg savings into reliable income that lasts. A way to do so – and generally get back more income per dollar compared to other alternatives – is through “pooled income.”

Though entities as commonplace Social Security and defined-benefit pension plans utilize pooled income approaches, few are aware of how such arrangements actually function.

Baby Boomers – especially those with 401(k)s and no traditional pension to fall back on – can benefit tremendously from a better understanding of the benefits of pooled income.

Below, from the writings of economist Moshe Milevsky, PhD., is one of the best – and most entertaining – descriptions I have ever read on how pooled income works.

The 95 Year Old Bridge Club

“My 95-year old grandmother loves playing bridge with her four best friends on Sunday every few months. Coincidentally, the five of them are exactly 95-years old, are quite healthy and have actually been retired – and playing bridge – for 30 years. Recently this game has gotten somewhat tiresome and my grandmother has decided to juice-up their activities. Last time they met, she proposed that they each take $100 out of their purse wallets and place the money on the kitchen table. “Whoever survives to the end of the year, gets to split the $500…” she said. “And, if you don’t make it, you forfeit the money…Oh yeah, don’t tell the kids.”

Yes, this is an odd gamble, but you will see my point in a moment. In fact, they all thought it was an interesting idea and agreed, but felt it was risky to keep $500 on the kitchen table for a whole year. So, the five of them decided to put the money in a local bank’s one-year certificate of deposit paying 5% interest for the year.

So what will happen next year? According to statistics compiled by actuaries at the U.S. Social Security administration, there is a 20% chance that any given member of my grandmother’s bridge club will pass-on to the next world during the next year. This, in turn, implies an 80% chance of survival. And, while virtually anything can happen during the next 12 months of waiting – actually, there are 120 combinations, believe it or not — the odds imply that an average four 96-year olds will survive to split the $525 pot at year-end. (I sure hope
grandma is one of them.)

Note that each survivor will get $131.25 as their total return on the original investment of $100. The 31.25% investment return contains 5% of the bank’s money and a healthy 26.25% of “mortality credits”. These credits represent the capital and interest “lost” by the deceased and “gained” by the survivors.

The catch, of course, is that the average non-survivor forfeited their claim to the funds. And, while the beneficiary’s of the non-survivor might be frustrated with the outcome, the survivors get a superior investment return. More importantly, they ALL get to manage their lifetime income risk in advance, without having to worry about what the future will bring.”

Click to view the original paper, “Grandma’s Longevity Insurance,” from Moshe Milevsky, PhD.

Important notes on the story:

In a real pooled income arrangement, the people don’t get to keep the money at the end. Instead, funds are allocated to assure that income for the remaining participants persists.

Those who live the longest do reap the greatest rewards. But, that’s really the point. People have the choice to cling to the funds they have and risk running out of money at later ages, or, let go, “jump in the pool,” and rest assured they will always have a guaranteed income no matter how long they end up living.

Few argue that individuals should put all of their funds into pooled income products. The key is to cover basic living expenses – food, shelter, utilities, everyday expenditures. Therein lies security. Once basic expenses are covered, more traditional investment alternatives would be preferred due to their liquidity, growth potential, and suitability for inheritance planning.

Relative to the issue of inheritance, it is useful to recall the warning flight attendants give to airline travelers, “Put the oxygen mask on yourself, before putting it on your child.” Similar logic applies to retirement funding, “Make sure to cover your basic income security, before worrying about leaving money to your kids.” (One idea is to leave kids your “stuff” instead – house, physical assets, etc.)

Mentioned in the story above is the concept of “mortality credits.” Mortality credits are what create the magic and give pooled income arrangements – including Social Security, pension plans, and individual annuities – the ability promise more long-term income to participants than other comparable mechanisms.

Assuming proper funding, mortality credits allow for the assets of pooled funds to be invested in highly safe instruments, such as intermediate and long-term bonds, and still deliver superior results.

Arguably, mortality credits may afford pooled funds the ability to take on a bit more risk to achieve their objectives. In grandma’s story above, if the group had put the $500 into a hot growth stock and lost 20%, the survivors would have still each gotten their money back.

Finally, securing basic living expenses with pooled income can give individuals more freedom to pursue higher investment returns with their remaining funds. This happens because a person’s “base” income is safely separated from his or her overall investment risk.

In summary, here are several major benefits provided by pooled income mechanisms,

  • They serve as a form of insurance to cover basic expenses in retirement.
  • They generally provide more retirement income per dollar allocated.
  • They protect against the risk of living too long and outliving retirement funds.
  • They insulate retirees from the ups and downs in the market.
  • They allow greater freedom to pursue higher returns with remaining retirement funds.
  • They provide a simplified means of translating retirement savings into steady, reliable income.

If you would like to learn more about the suitability of pooled income products for your situation, you are welcome to contact me by email or through my Cincinnati, OH based insurance agency, McCarthy Stevenot Agency, Inc.

Bonus content: Use this simple method to calculate how much basic income you may need in retirement.

Amazon links to other works by Moshe Milevsky, PhD. (Purchasing books through these “sponsored” links help defray the cost of this website. Thank you!)

How to generate income in retirement

Most people spend their careers saving and accumulating funds so that one day they can retire. But when retirement finally arrives, a whole new process begins.

Economists call it, “the decumulation phase.”

This is the process of turning saved or invested assets into regular income.

Decumulation is an entirely different animal than accumulation. Paying regular bills by slowly liquidating investment shares can be an extremely complicated task to undertake.

  • Which stock (or fund shares) should you sell first?
  • Should you sell shares of a stock that is up or a stock that is down?
  • Should you sell an average of all the stocks you own?
  • Should you be selling shares of some other investment such as a bond fund?

I often think of the challenges of decumulation when I am at the grocery store and see very senior people doing their shopping.

(OK…if that makes me some kind of economics/financial nerd, so be it. There is a serious human side to this story.)

I think to myself,

“Does this person now have to go home, log in to his or her online brokerage account, and sell shares to pay for those groceries?”

I also often wonder,

“What if this person is alone and has lost his or her spouse?”

What if the spouse who is now gone was the one who “took care” of the money?

What’s left is someone at a very delicate and vulnerable senior age – who is likely intimidated or even downright afraid – forced by necessity to manage an extremely complicated and difficult task, just to pay for basic things like groceries.

Yikes…

There is a better way.

There are products designed to generate and distribute income more smoothly. These products generally “pool” funds in order to distribute income steadily and predictably over time.

  • Funds of this general type date back to the Roman Empire when individuals were paid an annual stipend called an “annua.”
  • Roman soldiers received such stipends in exchange for military service.
  • Participants would make a single payment to the fund and receive payments each year until they died.
  • Other funds of this type – called tontines – were used during the middle ages by kings and lords to finance the cost of frequent military campaigns.
  • The first annuity used in America was established in Pennsylvania as a retirement fund for pastors in 1759.
  • Lotteries today use similar mechanisms to distribute prize money to winners. After an initial lump sum is contributed, funds are paid out evenly over a number of years.

Converting savings into income can be a very complicated process, but it doesn’t have to be.

After a certain age, for mercy’s sake, it really shouldn’t be.

Don’t leave your spouse trying to manage a “do-it-yourself” decumulation plan.

Learn how annuities can help convert savings into guaranteed, worry-free income and make the decumulation process a whole lot easier.

Try this simple method to calculate how much income you may need in retirement.

If you would like to contact me to discuss whether annuities may be suitable in your situation, I can be reached by email or through my Cincinnati, OH insurance agency, McCarthy Stevenot Agency, Inc., at 513-891-9888.

The secret to saving the Baby Boomers

By 2030, the last of the Baby Boomers will reach retirement age. At that time, nearly one in five Americans will be over the age of 65.

Many experts predict a retirement crisis will be arriving shortly thereafter.

The issue here is money…

  • Will Baby Boomers have saved enough?
  • Will the money they have saved last?
  • What will be the status of social safety nets like Social Security and Medicare?
  • Will the “do-it-yourself” 401(k) retirement model succeed in generating reliable income for such a sizeable retired population?
  • Will the possibility of market crashes, bubbles, and corrections complicate matters even more?

The solution for saving the Boomers

The solution for saving and assuring the future security of Boomers is income.

Especially guaranteed income that is immune to market turbulence, adjusts for inflation, and lasts for a lifetime no matter how long a person lives.

I’m not talking here about income to send people on exotic vacations or take trips around the world.

I’m talking about basic income that affords a person the ability to live with dignity.

  • This means income to buy food when you are hungry, to keep you warm when it’s cold, to help pay for medicine, everyday necessities, and keep a roof over your head.
  • This means income that will be there regardless of the future – no matter how long you live and no matter what your physical condition.
  • This means income to provide a backstop, a safety net, and insurance.
  • This means income powerful enough to say to a spouse with certainty, “I love you and even though one day I may be gone, this money will be here for you no matter what the future may bring.”

If a person lacks such basic income, it really can be a crisis.

Heartbreak. Destitution. Poverty. Hunger.

So, how does a person obtain the necessary income to cover his or her basic needs?

There are generally two sources for generating income in retirement, pooled income and investment income.

Pooled Income versus Investment Income

Pooled income should be used as insurance to protect and guarantee income needed for basic living expenses. After that, investment income should take the lead covering additional expenses and legacy planning.

Differences between pooled income and investment income.

Pooled Income

  • Pooled income – while still expensive – is the cheapest way to create lasting income and it provides the greatest guarantees for future security.
  • Money is placed in a shared “pool” and funds are withdrawn to provide income for participants.
  • Pools are typically administered by large insurance companies, pension plans, or government entities.
  • Income is usually guaranteed for life.
  • Depending on the source, cost of living adjustments may or may not be provided.
  • Except for survivor benefits, pooled income provides no inheritance for heirs.
  • Funds are illiquid – except for the checks a person receives every month.
  • For those living the longest, pooled income generates an enhanced yield that is virtually impossible to beat using conventionally traded instruments.
  • Examples of pooled income include Social Security (were it funded properly), traditional “defined benefit” pension plans, and annuities.

Investment Income

  • Investment income is generated by investment funds.
  • Investment funds tend to be more liquid and provide a greater appearance of control.
  • Generally, investment income requires a larger starting balance (when compared with pooled income) to generate the same sustainable targeted income amount.
  • May fluctuate based on the ups and downs of the markets.
  • Generally provides no guarantees.
  • Principle can suffer from market turbulence and funds can be depleted.
  • Is compatible with leaving inheritances, assuming funds last.
  • Allows for greater liquidity to make larger, immediate expenditures.
  • Funds may be invested in a wide array of investment alternatives.
  • Examples of investment income sources include IRAs, personal investment accounts and 401(k) type savings plans.

My intent is not to argue that either type of income is necessarily better than the other.

Both income types serve a valuable purpose depending on the need.

I am generally as opposed to relying on investment income to cover basic expenses as I am for using pooled income to finance luxuries.

The goal is to align the income types so as to provide the highest possibility for future success.

Covering the basics

We can help save the Baby Boomers by encouraging them where possible to seek guaranteed pooled income to cover their basic income needs in retirement.

The more basic income Boomers obtain from such sources, the safer they will be from running out of income and facing serious financial hardship in their senior years.

Have you ever wondered how much money you will need to cover basic living expenses in retirement? Click here for an easy way to calculate the income amount you may need.

So what do you think?

  • How well do you believe the stock market will serve to support the income needs of Boomers during their retirement years?
  • If you knew you had enough guaranteed income to support your income needs in retirement, would it give you peace of mind?
  • What do you think of the idea of forgoing inheritance for kids if it means gaining income security for your retirement?
  • What steps could you take to make your living expenses in retirement more affordable?

What if everyone bought the same hot stock?

Conventional wisdom suggests that the stock market is the destination of choice when it comes to laying the groundwork for future financial security and building personal wealth.

Since the rise of the 401(k) in the early 1980s, tens of millions of people have officially become stock market investors. Critics of the status quo worry that public awareness about the risks associated with stock investing needs to be improved.

Generally, I agree.

As such, I have been writing about some of the risks related to stock market investing that I feel people should know more about.

A few of the topics I have covered so far are,

In this post, I focus on two issues that serve as underpinnings for the often futile pursuit of so-called “hot” stocks or other over-hyped trends in investing.

These are the “fallacy of composition” and the “bandwagon effect.”

Fallacy of Composition

Fallacy of composition refers to circumstances in which something that is true for a “part” may not necessarily be true for the “whole.”

For example, if one person stands up at a baseball game, he or she can get a better view. But, if everyone stands up, no one gets a better view.

Similarly, if only a few people bet on a particular horse at the racetrack, they can win big. But, if everyone bets on the same horse, the payoff will be small.

The same logic can be applied to investing.

A share of stock is essentially a claim on a company’s current or future earnings. If a company has a finite amount of earnings, its current stock price may represent a very good value for a certain population of investors.

But, if everyone were to buy the same stock, the fortunes could change.

First, the stampede of new demand would likely drive up the share price.

Sounds like good news, right?

Then again, maybe not…

  • New investors buying the higher priced shares end up paying more for the same proportional share of the company’s overall earnings.
  • If the company’s stock was formerly priced at $50 and paid a dividend of $3.00 per share, the yield would have been a respectable 6%.
  • However, if demand drives the price of the stock to $100 and the dividend per share remains the same $3.00, the yield now becomes only 3%.
  • New investors pay twice the original share price to get half as much yield in return.
  • New investors also bear the risk that the stock price may fall due to the perception that shares have become overvalued.

The point is, what may have begun as a good deal for some, can end up becoming not nearly as good a deal after everyone (or a sizeable population) gets involved.

The Bandwagon Effect

The bandwagon effect refers to incidences where demand for a stock, commodity, or other investment is driven by social pressures such as, “everyone else is buying it.”

In such cases, people are moved to act because they feel societal pressure and/or the fear that if they do not act, they will miss out on an opportunity.

When combined, fallacy of composition and the bandwagon effect can serve to drive prices of stocks or other investments to remarkably high and unsustainable levels.

In general, the later a person arrives to the party, the more he will have to risk, the less he will stand to gain, and the greater the likelihood he will lose.

Mother knew best

It turns out, your Mom knew a little something about the about fallacy of composition and the bandwagon effect when she told you,

“Just because everyone else is doing something doesn’t mean that you should do it too.”

Sage advice for both life and for investing…

The next time you see the masses chasing the latest hot stock or other investment trend, exercise caution.

Just because everyone else appears to be getting involved, doesn’t necessarily mean it’s the right thing to do.

Click here to learn the MOST important secret to retirement success.

So what do you think?

  • Have you ever seen a situation where what was good for a few was not necessarily good the whole?
  • Do you believe the bandwagon effect has had an impact on current U.S. stock prices?
  • Do you think stocks today are properly valued or out of line?
  • Can the fallacy of composition be applied to participation in the market as a whole?

Should you be worried about a stock market bubble?

The future well being of citizens today depends more on the stock market than ever before in history. This is largely due to a shift in the 1980s away from traditional “defined benefit” retirement pension plans in favor of individual “deferred savings” plans like the 401(k).

This shift – unintended if you’ve never heard the story – opened the door for tens of millions of people to become stock investors.

Individuals now rely on stocks for the promise of future prosperity and as a means of assuring financial security in their senior years.

Coinciding with the shift toward stock investing has been a demographic shift in our country.

  • Roughly 8,000 to 10,000 Baby Boomers reach retirement age every day.
  • By 2030, one in every five Americans will be over the age of 65.
  • This change represents an increase over the current senior population of 66%.

The original purpose of the stock market was to serve as a mechanism for businesses raise capital through the exchange of “shares” of ownership in a company.

Whether the market will be suited to serve in its new role of funding consumable income for a large segment of the future population remains to seen.

One factor impacting this question is the recurrence of stock market bubbles.

What is a stock market bubble?

Stock market bubbles occur as a result of cultural, political, and economic trends. They represent a flight from reality that is neither rational nor easily predictable.

A key question when thinking about stock market bubbles is, do stocks at any given time reflect a reasonable representation of their underlying values?

In essence, are stocks worth the prices for which they are trading?

The most fundamental expression of the value of stocks is the “P/E” or price earnings ratio.

  • This ratio is simply the price of stock divided by the stock’s earnings.
  • If a stock sells for $50 per share and has earnings of $5 per share, its P/E “ratio” is, 10.
  • $50 share price / $5 earnings = P/E of 10.

Usually the earnings used to calculate P/E are based on what a company actually earned in the prior year. P/E ratios are also commonly calculated for collections of stocks as represented by indexes such as the Dow Jones Industrial Index.

Historically, the Dow has had an average P/E of about 15.

When former Federal Reserve Board Chairman Alan Greenspan made his famous remark about “irrational exuberance,” it was early in December of 1996. At the time, the Dow was trading around 6,700 with an average P/E of 25. However, it wasn’t until five or so years later in 2000/2002, that the bubble finally burst.

There have been at least five major bubbles in the last 116 years: 1901, 1929, 1966, 2000/2002, 2008/2009. Some point out that the time span between recent crashes has decreased.

Below is a chart from Nobel Prize winning economist Robert Shiller that shows real or “inflation corrected” prices versus earnings for U.S. Stocks from 1870 through modern times.

(For advanced students, see Dr. Shiller’s P/E chart reflecting “real” ten year trailing earnings.)

Robert Shiller S&P 500 S&P Composite Stock Price Chart

You can see from the chart above that bubbles generally occur in relationship to the spread between the prices of stocks and their earnings.

When the next bubble will occur is anyone’s guess.

The older people become, the less time they have to recover from the negative effects of market turbulence like bubbles. To protect themselves, individuals should become more aware of the risks associated with stock investing, seek help from a qualified advisor, and plan accordingly.

Click to learn how to create reliable income for your retirement regardless of whether the market goes up or down. 

What are your thoughts?

  • Does it surprise you to learn that the senior population is increasing by such a large extent?
  • Have you ever thought about or looked at P/E ratios before?
  • Do you think the stock market will be able to provide a reliable means of income security for our growing senior population?
  • Have you ever wondered how you will derive income from your nest egg to pay bills when you retire?