Monday, September 21, 2015

All the Stock Investors Are Above Average

Some time ago, I wrote a piece entitled The Chicken and the Pig explaining how a worker experiences a paradigm shift upon retiring, and another that I called Think Like a Bayesian Pig. Suddenly, upon retiring, conserving our wealth becomes far more important in our personal perspective than building more. I spoke on the topic at the RIIA conference in Charlotte last year.

The Retirement Income Industry Association was founded by Francios Gadenne. The first time I met Francois, we discovered that we had come to retirement planning in the same way. Both from the tech industry, we had found ourselves able to retire early, but couldn't find a retirement planner with whom we were comfortable. We each set out to improve that situation, Francois by creating RIIA, and me by blogging. Francois has probably reached more people more effectively, but I'm funnier.

My goal is to have the funniest, most entertaining retirement finance blog on the web, which is, as you might imagine, a very low hurdle.

I attended the RIIA conference in Indianapolis last week to receive an award for a paper I had written. At a dinner the night before, I sat across from a young lady who had seen my presentation in Charlotte. After a few minutes, her face lit up with recognition. “Oh, I remember you now. You're the Think Like a Pig man!”

It's good to have a brand. I guess.

For those of you who, like me, haven't been to Indiana in decades, I can report that it is still very flat, but I learned things last week that are more relevant to a retirement blog and I'll share them with you.

Dr. Moshe Milevsky gave a fascinating presentation on tontines, a medieval predecessor of life annuities. (Who knew it was even possible to give a fascinating presentation on annuities?) Moshe has written a book, King William's Tontine, which I have not yet read, but if it's anything like his presentation, I will love it.

A typical fact from his presentation: when England’s King William used a tontine to fund a war with the French, several shares were bought by Frenchmen. Now, that’s what I call a hedge.

I did read Milevsky’s “The 7 Most Important Equations for Your Retirement: The Fascinating People and Ideas Behind Planning Your Retirement Income over the weekend and found it fascinating, as well. But, that's me. Unless you love reading about the history of mathematicians, you probably won't enjoy either as much as I did. I concede that I may be in the minority on this. (If you do love this sort of thing, David Berlinski’s A Tour of the Calculus is still one of my favorites.)

Dr. Milevsky (@RetirementQuant on Twitter) gave us another of his books, co-authored with  Alexandra Macqueen, CFP, entitled Pensionize Your Nest Egg. I haven't read it, yet, but I did give it a thorough skimming. I found the following table (double-click to enlarge) that I thought you might find interesting. Look at the percentage of our budgets that Americans spend on Health compared to other countries. Scary stuff, and getting worse, but not at all surprising to me after my own ten years of retirement.

I have asked @RetirementQuant questions on Twitter and promptly received very valuable and insightful responses. (That alone is an impressive accomplishment – by the time he finishes saying “reciprocal gamma distribution”, he's already used his 140 characters.)

As with all conferences, some of the things we learn come from the attendees. One attendee pointed out that enough insurance companies that offer annuities have been bought out by private equity to alarm New York state's insurance regulators. The dramatic number of acquisitions has raised alarms in some circles about the safety of life annuities. There doesn't seem to be enough evidence to suggest that annuities are now at risk, but it's a topic we should all probably keep an eye on.

Another informal discussion I found interesting was the collapse of the number of fund managers who now outperform their benchmarks. Here’s a recent quote from Larry Swedroe at Advisor Perspectives:
“But the bottom line is that 20 years ago about 20% of active funds were beating their risk-adjusted benchmarks on pre-tax basis (much lower percentage on AT basis). But today that figure is about 2% even on pre-tax, making it likely it's maybe 1% on AT basis as taxes are often the greatest expense for active managers.”
There is just very little hard evidence that more than a thimbleful of stock pickers and market timers (think Dodd and Buffet) can outperform. In my experience, contrary to the evidence, many individual retirees feel certain that they are in that thimble or that they can find a magical advisor, blogger or investment club that is.

Swedroe wrote a book on this topic entitled The Incredible Shrinking Alpha, which I also downloaded to my Kindle and plan to read soon. For a shortcut, read Michael Kitces' outstanding summary.

Dr. Steven Huxley of Asset Dedication, and his co-founder, Brent Burns, discussed their company's strategy of implementing floors with individual bonds (they prefer agency and other Treasury bonds). When asked their reasons for eschewing annuities in the floor, they replied that their major objection to life annuities is cost (they optimize safety and cost) and added that the constant cash flows of annuities don't match the variable spending requirements of most retirees. I would add that annuities and bonds aren't an “either-or” decision and that variable cash flows can be achieved with a combination of the two.

They also agreed with my argument (Funds and Ladders) that individual bonds held to maturity are not identical to bond funds with the same duration. I think the argument that they are the same is quite flawed. (Dr. Milevsky had previously agreed with my argument indirectly, via Twitter, by suggesting that the fund and the ladder could perform similarly – but only if they have the same duration and convexity, i.e., both hold essentially the same bonds.)

Bond funds have sequence risk. Ladders of individual bonds held to maturity have future guaranteed redemption prices and dates that we know precisely. There is no sequence risk. A ladder of TIPS bonds held to maturity is cash. I asked Dr. Pfau his position on this argument and he simply replied, “I don't see much use for bond funds in a retirement plan.”

Finally, Dr. Brigitte Madrian also received an award at RIIA’s Fall Conference. Fortunately for me, my award was presented first. If I had to follow her presentation on her research, I would've feigned illness and hidden out in my room. Dr. Madrian's research on how we use 401(k)'s changed the industry and Federal regulations. Essentially, she uncovered the total irrationality with which most workers make decisions about their 401(k).

The scary part is that her sample was comprised solely of Harvard students, graduates, faculty and staff. So, if you invest your 401(k) in all cash, or all in your own company's stock, or you pick your savings withdrawals in 5% increments (“no one picks 7% or 13%”), you’re making poor choices but you're in well-educated company.

Wade Pfau, Michael Finke and several other retirement researchers of note also attended. Here are some of Wade's thoughts on the conference.

To paraphrase Garrison Keillor. . . that's the news from Lake Wobegon, where all the women are strong, all the men are good-looking, and all the stock returns are above average.

Monday, September 14, 2015

Maslow's Internet Service Provider

I recently explained to a commenter on my blog that he need not apologize for a “diversion” because we thrive on diversion here at the Retirement Cafe´. This is, after all, my hobby. To prove my point, I'll devote today's post to psychology and the “dismal science.

In 1943, Abraham Maslow introduced the “hierarchy of human needs” in which he more or less noted that people dying of thirst don't focus much on hamburgers, while even thirst tends to get moved to the back burner by people whose air supply has suddenly been cut off. There's a lot more to the theory, of course, and my college professors would have suggested long ago a bit of independent study at the library (a large building where physical copies of books were organized by index cards and stored), but which nowadays entails an effortless hop over to Wikipedia.

We studied Maslow in business school to understand discretionary and non-discretionary products and services, a concept that is also quite important to retirement planning. The idea was that in bad times some businesses do better than others because they fill genuine needs (food, water, medical care and the latest iPhone, for example) rather than discretionary desires like marble tile in the bathroom.

The scope of this theory was driven home to me several years ago when I visited my sister, who lived in Honolulu at the time. A hurricane had devastated Kauai and volunteers were loading emergency supplies onto a boat headed for that island. A KHON TV reporter interviewed one of the volunteers as he loaded the boat.

“What supplies are you taking them?”, she asked with the keen insight of a veteran journalist.

“Beer, rice. . . just the essentials,” he answered with absolute solemnity as he lifted another case of Primo onto the boat.

(Alcoholic beverage manufacturers are, in fact, considered non-cyclical, “defensive” stocks.)

This concept is important in retirement planning because in the worst possible outcome, you want to make sure that you can afford food, shelter and the latest iPhone. That's why we recommend that you carefully protect your non-discretionary spending.

You may be asking what any of this has to do with Internet Service Providers and I will now reveal that my Time Warner Cable internet service was knocked out by a storm last Thursday. Had I led with that, I would've lost you by the second paragraph because – let's face it – a Time Warner Cable service outage isn't exactly a rare, newsworthy event.

Despite much yelling and screaming at some poor customer support representative speaking to me from Bangalore in the middle of the Indian night (the wrong person for me to blame, for sure), I was informed that the earliest a repairman could possibly visit would be Tuesday, which would mean a nearly 5-day outage.

TWC's monopoly here is quickly eroding. AT&T offers fiber service to my neighborhood, but when I tried to get it installed a year ago, the installers couldn't figure a way to avoid running a cable up the outside of my house and drilling a hole through the brick into my kitchen. I told the guy to come down from the ladder and go away until he could figure out a better solution. Though he never came back, despite my making two more appointments, AT&T began billing me a few weeks later for the service they were never able to install. I somehow felt better paying for TWC service that sometimes works than for faster AT&T Internet service that couldn't be installed.

The other option is Google Fiber, which will soon be available in my Chapel Hill neighborhood. A few months back, Google promised to send me a free #FiberIsComing T-shirt if I signed up to receive occasional updates on their progress by email. Not only did I sign up for the T, I offered to help them dig up my street and lay the fiber. “Just paint a spot on the pavement,” I told them. “I'll bring my own shovel.”

So, where does Internet service fit on my personal version of Maslow's pyramid? The past few days have been enlightening.

TiVo sort of works in that we have stored several hours of TV shows that will easily hold us over for  4 or 5 days, but many features don't work. The guide is now outdated and we can't, of course, use TiVo to download Hulu or Nextflix without an Internet connection. My Nest thermostats are limping along but performing adequately, if not optimally, in their current “dark” mode. My Dropcams are frequently and annoyingly pinging my iPhone to tell me that they have no Internet connection. They are useless without it.

Our cell phones text and make voice calls easily, but don't have adequate signal to download email unless I walk upstairs to the northeast corner of the house. My son's bedroom, on the other hand, is in that corner and he has downloaded videos onto his iPhone non-stop for the past three days. I received a text message warning last night from Verizon telling me that he has used three fourth's of our entire family's monthly cellular data allocation in just three days and the month isn't half over.

(Exceeding our data plan will soon fix the problem with all those annoying apps telling me they can't access the Internet. I won't pay for more data so I can get more messages telling me that my Internet service is down.)

My son's online college class will require him to drive down to the library on Monday (the index cards have been replaced by Wi-Fi to download Kindles) to upload a paper that I hope he has written. Why they still call them "papers" is a mystery to me.

Without Internet service, I was able to finish an excellent novel with paper pages, an upside, of course, but my retirement research has been dramatically curtailed by the lack of collaboration tools. I found myself describing graphs over the phone to a co-author (my older son). “The three curves kinda goes straight for a while and then shoot upward and the lines split apart, ya' know what I mean?” I could print the graphs and mail them to him. USPS would deliver the letter before the TWC guy shows up.

I had forgotten that you have to turn book pages manually. I kept touching the right margin without result. Oh, and remember that you don't have to turn off hardcover books. Apparently, they time out and turn themselves off after you've gone to sleep. Battery life is amazing.

My wife sheepishly admitted yesterday that, without access to her weather app, she had needed to step outside to realize that fall temperatures had arrived.

What does this mean for Internet service and the retiree budget? When I list non-discretionary expenses, food and water are still going to be pretty high on the pyramid. My iPhone is a pretty poor substitute for Wi-Fi, but I'd hate to live without it. On my version of Maslow's pyramid, Internet service is high, but lower than food, water, shelter and the latest iPhone. Though an electric outage would be far worse, interruption of Internet service to our home is surprisingly disruptive.

I'm still thinking about where to rank beer.

The most enjoyable part of this experience? After I hung up on the TWC customer representative (politely), I walked down the hill to the mailbox and there it was – my free Google Fiber T-shirt.

Wednesday, September 2, 2015

The Fascinating (To Me, at Least) History of Sustainable Withdrawal Rates

I have always found the history of “sustainable withdrawal rates” (SWR) to be quite interesting (a fact that secures my qualifications as a geek, as if there might otherwise have been some doubt), so I enjoyed retirement researcher, Wade Pfau’s recent post, Safe Withdrawal Rates for Retirement and the Trinity Study.

As Wade's post explains, William Bengen published a seminal paper on the topic in 1994 (download PDF). The Trinity study, subsequently published in 1998 (download PDF), took a slightly different direction with important repercussions. The latter shifted focus from “the highest withdrawal rate possible in the worst-case scenario from history” to the proportion of thirty-year periods in which a portfolio would have (past perfect tense) survived.

As he also notes, both studies were based on historical market returns available in the mid to late nineties and basing a retirement plan on the assumption that future portfolio returns will equal or exceed those of the past is faulty logic. Given current capital markets, they are unlikely to, according to Pfau, Michael Finke and David Blanchett in The 4% Rule is Not Safe in a Low-Yield World.

There is another interesting piece of history regarding safe withdrawal rates that Pfau doesn’t include in his post. In the September 1995 issue of Worth magazine, Fidelity Magellan's fund manager, Peter Lynch, published an article entitled “Fear of Crashing” in which he suggested that a retiree should be able to invest her savings 100% in growth funds and safely spend 7% of the portfolio annually (damn, some days I miss the ’90s).

I apologize for not being able to provide a link to the Worth article. Apparently, 1995 was before the time that the Internet knew everything. Prehistoric, in today's world.

Scott Burns, then a financial columnist for the Dallas Morning News, published a challenge the following month, October 1995, entitled “Dangerous Advice from Peter Lynch.” Burns provided data showing that a retiree implementing Lynch’s advice would quickly have gone broke in many historical time periods.

(Timing is everything. Lynch wrote his column a year following Bengen’s paper. Burns apparently had read Bengen’s work; Lynch apparently had not. )

Lynch not only withdrew the “Fear of Crashing” statement, he hired Burns as a contributing editor for Worth, yesteryear's equivalent of hiring the guy who hacked you as your new security consultant, I suppose.

The story became even more interesting when, in 2010, Burns and economist Laurence Kotlikoff published “Spend 'Til the End”, in which the authors refer to the “rules of thumb”, like 80% replacement rates and 4% safe withdrawal rates that Burns had written about for so long in his columns, were better referred to as “rules of dumb.” (I recommend this book.)

SWR studies provide important insight into the portfolio survival process, but as Pfau points out, translating the results directly into a retirement plan is a risky proposition. I have concerns beyond Wade’s research showing that historical data is a poor basis for future expectations.

As I have previously pointed out on this blog, the model is based on the absurd policy that the retiree will continue spending the same amount annually even when it is clear that he is headed for ruin. As Pfau has noted, constant-dollar spending is a research strategy, not a retirement planning strategy. If your retirement plan is to spend a constant-dollar amount annually, you need a new plan.

Nonetheless, SWR studies can be enlightening and I find their history far more interesting than that of most retirement research – admittedly a low hurdle.