Tuesday, August 13, 2013

A Little Reality

I received a comment on my recent post, A $2.5 Million Rant, from a gentleman named “Anonymous” that I find quite intriguing. Anon doesn’t seem to realize that, for the most part, he and I are in agreement, but I’ll argue with him, nonetheless, because, well. . . I just like to argue.

My friend, Anon, either doesn’t read many of my posts or he’s missing the points. Maybe he isn’t the only one. Maybe I haven’t explained them well enough for some, so I’m using this week’s post to clarify. (Anon’s comments below are in italics.) 

I agree with a lot of what you say, but not necessarily the spin you put on it. Many of the problems you identify are simple economics. You cannot expect a guaranteed good return in the stock market.

True, but you miss my point. My complaint isn’t with stock market risk and return. Without stock market risk there would be no reward and the stock market rewarded me well over my career.

My complaint is that our politicians set up a retirement system based on the belief that individual families could harness that risk to fund their own retirement. And they created a windfall for the financial services industry. And now, our political leaders are doing nothing to fix it.

No, you can’t expect a good, risk-free return in the stock market. You also can’t expect the stock market to fund retirement for the vast majority of individual families.

My problem is your constant tone of outrage.

“Constant” is hyperbole, but someone needs to be outraged at our retirement system. William Bernstein is outraged. (“I've flown airplanes, and as a doctor, I've taken care of kids who can't walk. Investing for retirement is probably harder than either of those first two activities, yet we expect people to be able to do it on their own.”)

Helaine Olen is outraged. (“The truth is this: the concept of a do-it-yourself retirement was a fraud. It was a fraud because to expect people to save up enough money to see themselves through a 20- or 30-year retirement was a dubious proposition in the best of circumstances.”)

Teresa Ghilarducci was outraged, before Congress. (“It is now more than 30 years since the 401(k)/Individual Retirement Account model appeared on the scene. This do-it-yourself pension system has failed. It has failed because it expects individuals without investment expertise to reap the same results as professional investors and money managers. What results would you expect if you were asked to pull your own teeth or do your own electrical wiring?”)

John Bogel is outraged. (“Where are we in terms of our retirement health? We’re facing a train wreck.” and “We have a 401(k) system that is profoundly flawed even as it has moved to the position of pre-eminence in our retirement system. There are elements of the 401(k) system that are just unacceptable if you’re trying to build a system that accumulates for retirement.”)

If you’re not outraged, you don’t understand the situation.

You were duped.

(Besides, it’s my blog. I can be outraged if I choose.)

At whom, exactly, should these folks be "outraged"? At "the retirement system" or the government for not forcing them to save perhaps 25-30% of their income throughout their working lives?

They should be outraged at political leaders who sold them a bill of goods back around 1980. In the words of Helaine Olen, you might be tempted to ask, “what went wrong,” but a better question might be “why did we ever expect this to work at all?”

And they should be outraged that most American workers will drop out of the middle class after they retire and today’s political leaders are doing nothing about it.

 [Should they be outraged] at the economy for not guaranteeing future returns?

Now you’re just being silly.

Look, we can certainly improve the "system"; fine.

Ya’ think? It is failing about 95% of American workers so, yeah, maybe a little room for improvement there.

But to accumulate a lot of money for retirement now that quite a few people live into their 90s requires real sacrifices and not many people are signing up for that. Look at all the complaints about increasing taxes this year and realize that it will take MUCH more than that to fund retirement. Try telling folks you're going to require them to save at least another 20% of their income.

My point, exactly.

Our current retirement system requires a level of savings (sometimes 20% isn’t enough, Anon) that is ludicrous for the American middle class. Then it requires investment skills that even few professionals have. And on top of that, it requires that you be born in a fortunate year. (I’m still working on that one. A tardis, maybe?)

Do-it-yourself retirement funding doesn’t work for the vast majority. I don’t have the answer, but my gut tells me it must involve risk pooling to protect against longevity risk.

So, here’s what you missed, Anon. Our current retirement system doesn’t work. It doesn’t come close. This blog is an effort to help the 95% or more of Americans who haven’t saved enough for retirement. As I have posted often, there isn’t a tremendous amount I can do to solve a problem that began over 30 years ago, but I may be able to help you make the most of a bad situation.

Unfortunately for my generation (Boomers) and the next, it’s too late. But you can begin to be outraged enough to demand that someone fix it for your grandchildren.

We need a little realism here.

True that.

Friday, August 2, 2013

Retired Guy's Recovery from the 2007 Market Crash

In my last post, I used the following chart to demonstrate how much longer it took a Retired Guy's portfolio to recover from the 2007 market crash than it took a Working Guy's.

Throughout this period, Working Guy was saving an additional $6,000 per year in a portfolio that held 80% in stocks and 20% in bonds, while Retired Guy was spending $4,500 per year from a portfolio that held a 30% stocks.

This example begs the question, “Would Retired Guy's portfolio have recovered sooner with a larger allocation of stocks in his portfolio?”

In the case of the 2007 market crash, the simple answer is no. A more aggressive portfolio would have recovered even more slowly because it would have fallen much further by the March 2009 market bottom.

The S&P 500 index, as represented by the index fund SPY, recovered from the bottom much more quickly than Vanguard Total Bond Market index fund (VBMFX), as you would expect. The following chart from Yahoo! Finance compares the two investments from the bottom of the crash until today.

However, if you compare the two funds from the pre-crash peak, you will see that the stock fund only recently caught up with the bond fund.

The following graph shows Retired Guy portfolios with various allocations of stock over the period from the 2007 peak until recently. More aggressive allocations climbed back at a faster growth rate but had dropped further on March 2009.

Any stock allocation greater than 30% has not yet recovered by then end of July 2013. When will they recover?

If the current bull market continues, some Working Guy portfolios will probably recover in the next year or so. But, this bull is getting long in the tooth. We may also encounter another bear market before these portfolios return to their 2007 peak value and it could be years more before they recover.

Of course, Working Guy's portfolio recovered a long time ago, early in 2010 and more quickly than the S&P 500, because Working Guy continued to pour new savings into his portfolio without spending any of it. You can't do that after you retire.

It is entirely possible that many retirees will sell at the bottom and never regain their October 2007 portfolio peak balance.

But that has been the point of my last two blog posts.

Managing your portfolio after you retire is an entirely new ball game.