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?

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.