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?

The Risk of Sequence of Returns

For years we have heard it repeated over and over from the financial sector – and their willing allies in academia and the media – that investing in stocks will provide us the best possible returns over time.

In a recent post, I pointed out that one of the problems with this conventional wisdom is how one defines “over time.” Depending on when you invest, how long you stay invested, and the time frame in which you need your money back, can have a dramatic impact on your actual results.

But the difficulties don’t end there…

The risk of Sequence of Returns

This problem relates to the “sequence” or the order in which a person receives his or her investment returns while withdrawing funds from a portfolio during retirement.

It is an enormous concern, though few people have any idea it exists.

It is both uncontrollable and unpredictable, and, depending on how it plays out, it can lead to a the early depletion of person’s retirement fund.

Here’s how it works.

Consider the following three numbers:

-13, 7, 27

Add them up and you get 21.

Divide 21 by 3 and you get an average of 7.

This is called an “arithmetic average.” Similarly, the oft quoted “7% inflation adjusted rate of return including dividends on stocks over time” is an arithmetic average.

You can add the three numbers above in any “sequence” you like and you’ll still get a total of 21 and an average of 7.

-13 + 27 + 7 = 21. (21 divided by 3 = 7)
7 + -13 + 27 = 21. (21 divided by 3 = 7)
27 + 7 + -13 = 21. (21 divided by 3 = 7)

But, here’s the rub…

The order in which those numbers appear as “returns” in a person’s portfolio can have a major impact on how long his or her portfolio lasts during retirement.

Let’s take the same three numbers: -13%, 7%, 27%, and apply them in different orders as rates of return on a portfolio that is funding systematic withdrawals – just as would be the case for someone funding his or her retirement.

  • We’ll start with a $100 nest-egg and take $10 out of the portfolio each year to pay bills.
  • We’ll run two sequences, both with 7% average returns
  • The only difference between the two scenarios is the sequence or the order in which the returns are achieved.

In Sequence One, the order of returns will be: -13% in year one, 7% in year two, and 27% in year three. The returns will continuously repeat for a running average return of 7%.

In Sequence Two, the order of returns will be: 27% in year one, 7% in year two, and -13% in year three. The returns will continuously repeat for a running average return of 7%.

Let’s see what happens…

Sequence #1

Sequence Number 2

Sequence Two ends up yielding 44% more income than Sequence One (i.e. $168.37 versus $116.81) and lasts five years longer.

This happens with exactly the same $100 nest egg, exactly the same rate of withdrawal, and exactly the same long-term average rate of return.

The only difference is the unpredictable and uncontrollable sequence of returns.

These examples show that a difference in the order of returns – notably, more negatives in the early years just before or just after retirement begins – can have a dramatic impact on how long a person’s retirement money will ultimately last.

Click to learn more about how to overcome the risk of sequence of returns and guarantee you never run out of income in the future – regardless of how long you live or what the markets do.

So, what do you think?

  • Have you ever heard of the risk of “sequence of returns” before?
  • With tens of millions of people in 401(k) type plans that may be affected by this concern, why don’t we hear more people talking about it?
  • Does the example above illustrate the concept clearly enough?
  • What other issues does becoming aware of this risk bring to mind? (I’ll tell you one – women are the most at risk because they live substantially longer than men…)

Email me your thoughts or comment below.

Is it always a good time to invest in stocks?

Since starting my career in the late 1980s, I have heard the continuing mantra from contemporaries in the insurance and financial sector, as well as many in the media, that, in general, it is always a great – or at least a good – time to invest in stocks.

Usually this premise is supported by some reference to the historical average returns of stocks and how they have outperformed nearly all other forms of investment over time.

However, after watching the markets bubble and burst several times in recent years, and thinking about the economic conditions into which tens of millions of Baby Boomers will soon be retiring, I have become more and more skeptical of such conventional wisdom.

So, is it really always a great or even a good time to invest in stocks?

It turns out, maybe not.

Yes, stocks have outperformed many other forms of investment over the long haul.

But therein lies the rub…the long haul.

In the 1900s, there were three major stock market bubbles: 1901, 1929, and 1966. What’s news to most people is that in each of these cases, the twenty years following those bubbles were effectively stock market depressions.

Here are the returns for the twenty years following each of the 20th century bubbles, including dividends and adjusted for inflation to provide “real” average rates of return,

  • Twenty years following the 1901 bubble, -0.2%.
  • Twenty years following the 1929 bubble, 0.4%.
  • Twenty years following the 1966 bubble, 1.9%
    (Source: The Great 401(k) Hoax, Wolman & Colamosca, pp. 20.)

Such rates of return would hardly have supported adequate means for retirement security during these periods. Further, the results would have been especially devastating for those regularly withdrawing funds from investment accounts to pay ongoing bills.

Fast forward to the new millennium.

Below is a chart compiled by 2013 Nobel prize winning economist Robert Shiller of Yale University from his bestselling book, Irrational Exuberance. The chart reflects “real” inflation adjusted rates of return from stocks, including dividends, going back to 1870.

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

(For an updated chart visit: http://www.econ.yale.edu/~shiller/data.htm)

In 2000, stocks experienced another major bubble. Then, they did it again in 2008/2009.

  • Given the decades-long malaise that historically tends to follow such occurrences, what do you think the outlook will be for the next several decades of stock investing?
  • What impact will potentially anemic markets have on the millions of Americans now staking their future retirement security on equity-driven 401(k) plans?
  • By 2030, nearly one in five Americans will be 65 or older. Will future retirees be able to reliably fund basic living expenses utilizing such resources as a backstop?
  • Were the equity markets ever intended to become the primary means of financial security for such a large segment of the population?

Let me know your thoughts by email or in the comments below.

This article is one in a series of articles I am writing to help promote thought and discussion about how individuals can achieve greater peace of mind and security in retirement. Learn more and get Free access to future articles at this link.

How long will you live?

Everyone hopes for a long and happy life, but did you know economists actually consider living too long to be a risk?

They even have a name for it, “longevity risk.”

It is the condition of living so long that you end up outliving your money.

Find out your average life expectancy using Social Security’s “Life Expectancy Calculator”.

Because no one knows for sure how long he or she (or a spouse) will live, the issue of life expectancy can complicate retirement planning. Think of it like trying to plan a dinner party without knowing how many guests are going to show up.

The good news is, with a few simple planning steps, most of the worries surrounding this issue can be solved.

Facts about the “risk” of living too long,

  • People are living longer now than ever. Improvements in medical technology, disease prevention, treatment, and management have lead to longer and longer life spans.
  • How long can a person live? The answer is really unknown. So far, the oldest living person on record was Jeanne Calment of Arles, France. Jeanne died in 1997 at the age of 122.
  • What is the average life expectancy for U.S. retirees? If you are 65 today, average life expectancy is 84.3 for a man and 86.6 for a woman. Note…these are only averages, so half of the population will live even longer!
  • Marriage is a factor. Married people retiring today have about a 50% chance that at least one member of the couple will live to age 92.
  • Women are more at risk. Because women live substantially longer than men, they are much more likely to become impoverished in older ages.
  • Your precise risk is unknown. An individual person’s exact longevity risk is difficult to determine because it is derived from a mix of factors including, available retirement funds, rates of return on future investments (or market losses), retirement spending rate, inflation, future medical expenses, family health history, and lifespan.

How to solve the problem of longevity risk?

The most important factor for overcoming longevity risk is having enough INCOME to pay your basic living expenses in retirement – especially guaranteed-for-life income that lasts no matter how you live and adjusts for inflation.

For most retirees, guaranteed life income comes from three major sources:

  • Social Security
  • A company (or government) pension
  • Life annuities

Click here for a simple way to calculate how much income you need in retirement and learn FIVE ways to make the cost of retirement more affordable.

Often, people end up combining several sources of income to achieve their retirement goals. The idea isn’t necessarily to have all of your income come from guaranteed sources, but enough to cover your basic living expenses and give you peace of mind. Studies show that retirees with more guaranteed income have less stress and more enjoyable retirements.

So what do you think?

Have you ever thought living too long could be a risk? Do you know of anyone who has outlived their money? What about the issue of women being more at risk? As a husband and a father, I do not want to leave the risk of my wife suffering poverty in very senior age to chance.

Feel free to email me comments or questions. You can also post comments below.

Why income beats savings in retirement

Imagine yourself far in the future. Yesterday, you celebrated your 82nd birthday! It was an enjoyable day spent with family and friends followed by a relaxing dinner with cake, ice cream, and many happy memories.

But this morning you awoke to some troubling news…

When you clicked on your favorite news app, you learned that an overnight far-eastern currency concern has sent U.S. markets into a tailspin.

As the next several days go by, market conditions rapidly deteriorate. The damage even begins to spread to other sectors. Both real estate and bonds start taking substantial hits.

Logging into your online brokerage account, you watch your account balances dropping more and more each day. Years and years of hard-earned savings are vanishing before your eyes.

You ask yourself, “Is this ever going to end? Should I be selling? Should I be staying put? Will my retirement funds be able to survive this latest ‘correction’? If not, how am I going to pay my future bills?”

This story is just a sample of the kind of worry that can arise when long-term retirement income is based solely on invested savings and systematic withdrawals from savings.

Do you currently have only a 401k plan and no guaranteed company pension?

Then, someday, this could be you…

The good news is, however, with a few simple planning steps, there are ways you can help reduce or even eliminate many of the above concerns. In fact, it can even be possible to establish a foundation for a reliable and worry-free retirement income.

The key to doing so is locking down enough guaranteed retirement income to cover your basic future expenses.

Guaranteed income is money that will be paid to you no matter what happens in future markets and no matter how long you end up living. Guaranteed income can be derived from a variety of sources including a combination of Social Security, a company or union pension, and life income annuities.

How much retirement income will you need?

Many planners point toward a “target” for retirement income that is equal to roughly 70% of a person’s pre-retirement income. In general, the more “base income” a person has from guaranteed sources, the easier time they will have meeting ongoing expenses in retirement. Studies show that individuals with more guaranteed income during retirement are also known to be happier and have less stress in their senior years.

How to create a successful retirement income plan

The fundamental elements of building a solid income plan for retirement are as follows;

  1. Reduce your long-term retirement living expenses where possible (downsize, simplify your life, pay off any mortgages or consumer debt).
  2. Establish an emergency fund for short-term cash needs (set aside the equivalent of six months to a year of income in an easily accessible FDIC-insured bank account).
  3. Calculate your NEEDED retirement income using the 70% rule or other similar method.
    (pre-retirement income = $100,000. 70% of $100,000 = $70,000)
  4. Add up ALL the income you will have from GUARANTEED sources such as Social Security, pensions, and life annuities.
    ($46,000 Social Security + $0 company pension + $0 annuity income = $46,000)
  5. Subtract your GUARANTEED income from your NEEDED income. This is your income “gap.” ($70,000 – $46,000 = $24,000 income gap)
  6. Click here to learn more about ways to fill your income gap!

Once funding for your basic income needs is set, you can think about allocating your remaining assets for future savings, special purchases, investments, and legacy planning (i.e. money that you plan to leave to kids, grandchildren, or charity).

For most people, covering basic retirement living expenses through guaranteed income will be better than relying on savings. Guaranteed income takes uncertainty out of affording your monthly bills and removes stress about what will happen to your savings in future markets. Guaranteed income also simplifies planning and assures you will receive a “check” each month no matter how long you our your spouse may live.

When added together, the benefits of guaranteed income help lead to a happier, more secure, and more relaxing retirement.

So, what about you? Do you worry about how to create income for your retirement? Do the potential ups and downs of the market bother you? If so, what is your plan to solve for this problem?

Let me know your thoughts by email or in the comments below.

The accidental rise of the 401(k)

Did you know that the 401(k) was never intended to be the primary vehicle to cover people’s retirement? In a cascade of unintended consequences, following no serious public policy debate on the issue, many Baby Boomers now find themselves at a destination in which they were never intended to arrive.

Take a look at this Marketplace article published in June 13, 2013. It features an interview by reporter Scott Tong with Ted Benna, widely considered to be the father of the 401(k):

Father of modern 401(k) says it fails many Americans

A few quotes and observations from the article,

  • Benna says, “…the 401(k) was never intended to cover everyone’s retirement.” Further, he observes that the current system is too complicated and incurs sizeable and unseen fees.
  • Per Benna, “Hey, if I were starting over from scratch today with what we know, I’d blow up the existing structure and start over. What I’m talking about isn’t 401(k). I’m talking about the way investing is done.”
  • The rise of 401(k) plans was accidental. In the past workers had company pensions and Benna was in the business of helping run such plans. In the 1970s, business owners were looking for ways to gain bigger tax breaks.
  • In 1978, Congress passed a hardly noticed add-on to the tax code in Section 401. It was a paragraph denoted with the letter “k.” It represented a tax break that allowed workers to put away cash on the side.
  • Added to this concept was the idea to allow a “match” or incentive to encourage workers to save more. Benna suspected the idea would take off. And it did.
  • In the early 1980s, with big companies leading the way, the new plans were offered in droves. Before long, even companies that never before had any type of retirement plan, were offering the new option.
  • Companies also started ditching what were perceived to be costlier traditional pensions plans – i.e. plans that offer a defined benefit at retirement, say 70% of a worker’s final salary payable for life.
  • Thus, the door was opened, on a completely serendipitous and unintended basis, to the DIY retirement era. Responsibility and risk for making plans a success was transferred from employers onto individual employees.
  • Another unintended consequence was that plans caused increased levels of stock ownership. Benna observes, “Unfortunately, the worst thing that happened with this wretched market is too many had the highest stock ownership that they ever had at the wrong time.”
  • During the mid-1990s bull market, participation in 401(k) type plans rose to 30 million Americans. In spite of this rise in popularity, roughly half of workers in America today still have no retirement plan.
  • Studies suggest that the typical middle class household as only about ten percent of the funds needed for retirement.
  • Benna never meant for this concept to become a do-it-yourself system that would replace traditional pension plans. But now, “This is kinda the whole enchilada…It’s not good, but it’s reality.”
  • The idea was “…simply a financial product that took off.”

So what are your thoughts? Should it bother anyone that such a major piece of piece of public policy happened essentially by accident? I suppose many good things got started that way. Is this one of them?  What are things people can do to make up for the shortfalls they are finding with their 401k plans? What have you tried?

Let me know your thoughts by email or in the comments below.