Quick note: I’m in the process of redesigning the Intentional Retirement website. If you have any thoughts or suggestions on ways to improve it or make it more helpful to you, please hit “reply” to this email and send them my way. Now on to today’s article…
Save more or work longer?
One of the first things I do for new clients is create a detailed retirement plan based on their unique circumstances. This helps us determine if they’re on track financially for the type of retirement that they want. Sometimes this exercise produces smiles. Sometimes not so much.
If a plan is falling short, there are many ways to get it back on track. You can save more, change your allocation, work longer, work part time, change your Social Security claiming strategy, get out of debt, spend less in retirement or downsize to a smaller house. The effectiveness of those options varies.
The most obvious tactic is to save more, but the power of saving diminishes as you approach retirement. Why? Because each new dollar has fewer years to compound. A dollar saved at 25 becomes about $22 by retirement (assuming an 8% annual return and retirement age of 65). A dollar saved at 55 only becomes about $2 by retirement.
A recent report from the National Bureau of Economic Research illustrated this point by showing that saving another 1% of your salary each year for 10 years is only as effective as working for a single month longer.
To explore this idea further and look at the effectiveness of different tactics, I thought it would be interesting to look at an actual retirement plan and see which changes produce the biggest results. Below is a short video of me working through a plan and testing potential changes to improve the overall success rate of the plan (If you have trouble viewing the video, click through to our site and click on the YouTube link).
I did an interesting exercise this week. If you’ve ever looked at a copy of your Social Security statement, you know that page 3 shows how much you’ve earned each year throughout your life. As I looked at mine, I was suddenly curious about something, so I grabbed a calculator and added up my lifetime income. Then I opened my financial plan to get a quick snapshot of my net worth and I divided my net worth by the total of what I’ve earned. The result was a rough calculation of what I have to show (financially at least) for twenty plus years of work.
This was at once both encouraging and discouraging as well as illuminating and thought provoking. Encouraging because I’ve managed to hang onto a decent percentage of that income over the years and then invest it in a way that has caused it to grow. Discouraging because there’s a larger percentage that we didn’t manage to hang onto. Sure, part of that went to feed and clothe us and part of that went to fund experiences and memories I wouldn’t trade for the world, but I know that a not insignificant portion went to a category I’ll charitably describe as “non-essential.”
The interesting and enlightening part of the exercise came when I widened the aperture a bit and rather than just thinking about my lifetime earnings, I thought about my lifetime instead. Or more succinctly, my time. How have I spent, saved and invested my time? I’ve been “paid” 45 years of time. How much of that have I used wisely and intentionally? Alternatively, how much have I just allowed to slip through my fingers? Have I used my time at work to create a career that is enjoyable, rewarding and useful to others? Have I used my free time to invest in my family, develop my friendships and pursue interesting things? Have I used my time and attention to invest in my health so that I can “earn” more time? The answers to those questions aren’t necessarily as black and white as a bank balance, but if you put “time wasted” on one side of the scale and “time well spent” on the other, you can get a pretty good idea of which way it leans.
Similarly to when I did the financial exercise, the time exercise was both encouraging and discouraging. Much of my time was well spent and much (either by omission or commission) was poorly spent. If I’m being honest, there are days, weeks and even years where I wish I could get a do-over. There’s nothing I can do about that now, however, except learn from it. So I’ll internalize those lessons and do my best to be a better steward of my “time wealth” going forward. I’ll try to be a good steward of my finances too, but I suspect that the closer I get to the end of my life, the less I will care about how I invested my money and the more I will care about how I invested my time. You too? Then do something about it so when you come to the end of your years, you’re not left wondering, “Where did it all go?”
“It’s not that we have a short time to live, but that we waste a lot of it.” ~ Lucius Seneca
The current bull market is 9 years old. That’s the second longest on record and it has people wondering how much further it can go. That question has taken on added urgency given the recent volatility, rising interest rates and political uncertainty. Markets lost ground in February (the first losing month in over a year) and they’re on track to close lower in March as well. Is this the beginning of something bigger? Should you make changes to your portfolio or otherwise prepare for a deeper downturn? I’ll share my thoughts below.
Keep Things in Perspective
First of all, I think it’s good to keep things in perspective. Yes, there have been some scary drops recently. In February, the Dow had its two biggest point drops ever. The S&P 500 had four of its largest drops ever. On a percentage basis, however, those drops didn’t even crack the top 20. Still, when the daily loss has a comma, it’s disconcerting. Just try to remember that pullbacks are natural and healthy, especially after the outsized gains we’ve had over the last several years. At the beginning of this bull market (the end of the Great Recession) the Dow was below 7,000 and the S&P was below 700. Now, even after the recent selling, they’re around 24,000 and 2,600 respectively.
Watch the Fundamentals
Warren Buffett has famously said that in the short-term the market is a voting machine, but in the long-term it’s a weighing machine. In other words, fundamentals matter more than feelings. How do the fundamentals look? In a word, strong. GDP and corporate earnings are growing at the fastest pace in years. The tax cuts will boost profits even more. Job creation continues to surprise on the upside. Unemployment is low. Consumer sentiment and consumer spending are very strong. Interest rates are still relatively low. Most signs point to a healthy and growing economy.
3 Key Risks
While most indicators are positive, that doesn’t mean that investors should be complacent. The bullish case is always strongest right before it’s not. And even if the fundamentals stay strong, you can still get some nasty price corrections. What are the key risks?
I see three primary risks right now: 1) Valuations, 2) Interest Rates, and 3) Political/Geopolitical risks. Because of the strong economy, stocks have been going up and valuations are at the upper end of their historical range. Markets are priced for perfection. What if we don’t get it? To quote John Mauldin, an economist I follow, “the consequences of a mistake are growing.” Or what if the Fed raises rates too aggressively? That could tip the economy into recession. And the uncertainty in Washington is not helping. If we get into a trade war with China or the Mueller investigation finds serious wrongdoing, markets will not react positively.
How to Protect Yourself
I said earlier that pullbacks are healthy. What do I mean by that? Economist Hyman Minsky had a theory that stability leads to instability. In other words, when the economy and markets are good, it encourages more and more risk taking. People start to focus on reward and ignoring risk. They invest too aggressively. They take on too much debt. They save less. They get complacent. And then a shock hits the system, losses start to build and people panic. The bottom falls out. That sudden instability is referred to as a Minsky Moment. The longer the period of stability, the greater the likelihood that people are making decisions that will eventually lead to serious instability. Periodic corrections are healthy because they keep people from straying too far from home.
Which brings me to the question at the beginning of this article. Should you prepare for a deeper downturn? The answer, of course, depends. During this 9-year bull market, how far have you strayed or drifted from your appropriate investment and retirement strategy? How can you tell? Here are 7 areas to look at closely.
Risk Tolerance. The longer a bull market goes, the less people worry about (or even think about) risk. That’s a problem, because the economy and markets usually revert to the mean. What would mean reversion look like now? We’ve gotten a taste of it over the last several weeks. After years of rising markets, they start to fall. After years of almost non-existent volatility, it spikes. After a decade of historically low interest rates, they start to climb. If the market dropped 20-30% this year, how would that impact your portfolio? Could you (would you) just ride it out? If not, you should probably dial back your risk.
Asset Allocation. The two primary ways to manage risk are through diversification and asset allocation. Look at your portfolio. Do you have any outsized positions? Is your stock/bond balance appropriate given your risk tolerance? Has your allocation drifted or changed over the years? Review your portfolio and align your asset allocation with your risk tolerance.
Time Horizon. All of this is a bigger deal if you’re at or near retirement. You have less to worry about the longer you have to go. Even after the 57% peak to trough drop in 2008-09 the markets fully recovered within about 4 years. Those who rode it out did fine. Could you ride out another major downturn? If you’re already retired, maybe not. At the very least you’re 9 years closer to retirement than you were during the last serious pullback. And even if you have time, sharp drops can cause you to make mistakes and do the wrong thing at the wrong time, so see points 1 and 2 again. Make sure you understand your risk tolerance and that your allocation is aligned with that.
Spending. Most people have lifestyle bloat as they get older. As income grows, so do expenses. Bigger paychecks mean better houses, cars, vacations, wardrobes and gadgets. That’s not necessarily bad, but the longer good times persist, the closer we tend to push our spending to the outer limits. That makes a person financially fragile. It can cause stress, limit your options and force you to make compromises in life. You control your spending. Beware of bloat. The more you live below your means, the more financially resilient you will be. And when you splurge on things or add expenses, do your best to make that spending discretionary rather than fixed. That way you can dial back if your income drops or the economy heads into recession. See this article on how to use dynamic spending to make your money last.
Debt. One of the characteristics of long bull markets is that people load up on debt. The boom years make them more comfortable borrowing for cars, houses and credit cards. Having debt adds risk and reduces cash flow, two things that are especially troublesome for a person at or near retirement. If you want to be better positioned to weather a financial storm, get rid of debt.
Saving. The average savings rate in 2015 was 7.19%. In 2016 it fell to 5.98%. Last year it fell to 3.74%. Care to guess which direction it will move in 2018? This is what Minsky was talking about. Stability leads to instability. People become complacent. They save less, which means they have less of a buffer, which means they’re less able to weather a storm.
Cash. It’s always a good idea to have a portion of your portfolio in cash or short-term securities. That way, if markets drop and a good investment opportunity presents itself, you’ll have some dry powder to invest. Or, if you’re already retired and taking distributions from your portfolio, you can pull your distributions from your cash rather than selling your stocks into a declining market.
Will the markets drop further? Who knows. The risk is certainly there. The important thing is to focus on the things you can control and make sure that if we get another downturn, it won’t derail your plans.
Hi all. I hope you’ve been well. Sorry things have been quiet around here for a few weeks. As I’m sure you know, the markets have been kind of crazy this year and most of my time has been spent on the phone or in meetings with clients. Between that, annual reviews and an unexpected trip to Australia (more on that in another post), I haven’t had much time to write.
With that said, what the heck is going on with the markets?!? And what, if anything, should you be doing about it? Here’s a quick summary:
The Chinese economy has been slowing. Why? Several reasons. The population is aging. The Chinese currency—the Yuan—is overvalued and making their exports less competitive. Debt in China has skyrocketed. This last point is likely the most significant. Much of the debt in China was used to fuel their breakneck expansion and to meet their predetermined (i.e. not demand driven) GDP targets. This has resulted in no shortage of questionable investments and misallocated capital. I saw this first hand when I was in China several years ago. The skyline was dotted with construction cranes, but enormous new buildings sat empty. Countless high-rise apartments were built regardless of the fact that most Chinese couldn’t afford to live there. Highways, bullet trains and even entire cities were built without much concern for whether or not they were necessary. The fear is that many of those loans will never be repaid and will eventually put a significant strain on the Chinese banking system. The government is trying to engineer a soft landing, but the jury is still out on whether they’ll succeed. In the meantime, the economy is slowing and Chinese demand for commodities has dropped dramatically, which leads me to Point 2.
By some estimates, China consumes about half of the world’s commodities. As their economy slows, their demand for things like copper, steel and especially oil has dropped significantly. Add to that OPEC’s decision to open the floodgates and Iran finally pumping oil after decades of sanctions and commodities have been in free fall. This is generally good for the consumer, because gas is cheaper, but bad for many others (e.g. oil companies, employees at those companies, stockholders of those companies, banks with energy related loans, high yield bondholders, oil producing states like Texas and North Dakota, and countries that are heavily energy export dependent like Brazil, Venezuela, Canada and Russia).
Too much debt is never a problem. Until it is. Most people probably think we have less debt in the system now than we did during the 2008 financial crisis. After all, those bad home loans were mostly written off, Europe smacked Greece into shape and consumers and businesses shored up their balance sheets, right? Um, no. Unfortunately, China isn’t the only one that has piled on debt. Debt is higher now in every category—household, corporate, government, financial—than it was in 2007. The latest numbers I could find put debt $57 trillion (with a “T” like The Titanic) higher than in 2007. That’s a big gain in a short period of time and it has investors nervous. Confidence greases the gears of the global financial system. If lenders lose confidence in borrower’s ability to repay, things get dicey.
From the “what will they think of next” file, many Central Banks around the world have started adopting negative interest rates. That’s right, zero apparently wasn’t low enough. Now they’re moving to negative. ZIRP (zero interest rate policy) has given way to NIRP (negative interest rate policy) in countries such as Denmark, Sweden, Switzerland and Japan. The logic is to force banks to lend, weaken currencies to help exports and stimulate economies. Not surprisingly, there are a lot of people who think these policies could come with some pretty significant unintended consequences. This uncertainty has only added to the volatility.
Result: Market Volatility
Markets HATE uncertainty and all of the above have combined to give investors a heaping dose of it. Not surprisingly, most markets around the world are off to a rough start this year with 10-20% drops the norm. But don’t panic. If you go back through the archives at IR, you’ll see that I write an article like this one about once a year. The causes of the volatility change, but not the regularity. So you don’t want to overreact, but you do want to be defensive and make sure that your plans stay on track. The goal is to protect your retirement. As I’ve said many times before, the best way to do that is to Focus on Things You Can Control. That means things like asset allocation, security selection, debt, savings and cash to minimize sequence risk. Focus on those things and this too shall pass.
To a large degree, happiness is being able to do what you want when you want. To get to that point, however (and here’s the paradox), you often have to do what you don’t want when you don’t want. Case in point: Retirement.
All of that is still true, but I want to give you a quick reminder.
You still need money.
I didn’t say that retirement was not a math problem or that money had no role to play. (see this, this and this for articles on preparing financially). Instead, I said “more than.” In other words, it’s money plus something else. Money plus meaning.
Why the reminder? I got an email from a reader named Patricia recently that discussed this very topic. Here’s a brief excerpt:
“I am one of those people who deferred. I worked really hard for 30+ years, saved like hell, deferred life in many ways so we would be able to retire early. And according to you, I totally screwed up.”
First off, there are many things that fall under the category of “screwing up” in my opinion, but working hard and saving so you can retire early is not one of them. Hat tip to Patricia (she and I had a nice conversation via email) and anyone else out there who is doing what it takes to build a nest egg and achieve financial independence.
Second, I took Patricia’s email seriously, because if she felt that I was somehow disparaging the savers and deferrers (is that a word?), then others of you may have had that feeling too. Nothing could be further from the truth. Hard work and disciplined saving is absolutely critical if you’re going to meet your retirement goals. That said, the money without the meaning is pointless just like the meaning without the money is often unrealistically out of reach. It’s up to each of you to balance those competing interests in a way that works for your life and goals.
In 8 Habits of Successful Retirees, I told you to live with a sense of urgency (#1), retire to something, not from something (#4) and choose yes over no (#6). Just don’t forget Habit #5: Retire based on your bank account, not your birthday. Run after the meaning, just don’t forget about the money.
On Monday morning my friend texted me: “Holy cow! Don’t jump!” He was referring, of course, to the 1000+ point drop in the Dow. Thankfully, after more than 20 years in this business, I’ve gotten used to wild swings, so I wasn’t on the ledge (although in 2008 I was glad I work in a one story building). That said, volatility in the market can produce much fear and anxiety, especially if you’re at or near retirement. There is a 100% chance that market volatility will continue, so here are 5 things I’ve learned after two decades of bulls and bears that can help you keep your retirement plans on track.
Markets have recovered from every single downturn in history. Every. Single. One. The Panics of 1893, 1896, 1901 and 1907 (Seriously, calm down already!). The Crash of 1929. The recession of 1937-1938. The Flash Crash of 1962. Black Monday in 1987. The crash after Iraq invaded Kuwait. The 1997 crash caused by the Asian currency crisis. The Dot-com bubble in 2000. The crash after the September 11 attacks. The selloff in 2002. The financial crisis of 2007-2009. The Flash Crash in 2010. The markets are higher now than after every panic, bubble, crash and crisis in history, but be careful because…
You are not the market. Your personal experience with market volatility will largely be impacted by the actions you take before and during a crisis. Were you poorly diversified? Was your asset allocation totally inappropriate? Were you taking too much risk? Did you sell in a panic? Did you wait to get back in until the markets had already recovered? Did you stop making 401(k) contributions when things went south? Investment returns are not investor returns. Each year Dalbar does a study to see how well the average investor does compared to the markets. In short, the average investor only captures a fraction of the market return, largely because of poor behavior, so…
Sometimes it’s good to have help (especially if you’re near retirement). There are some people with the time, temperament, knowledge and discipline to handle their investments on their own. Others could benefit from a little help. This is especially true the closer you get to retirement because the issues you’ll be confronted with are different. Before retirement the major issue is saving. Most of us are at least familiar with the concept of saving (regardless of whether or not we’re doing it). We’re less familiar with the many moving parts that make up the typical retirement plan: calculating how much is enough, settling on an appropriate asset allocation, risk management, cash flow management, pension payouts, periodic rebalancing, retirement plan distributions, estate planning, Medicare, Social Security and the tax consequences of certain distribution strategies. You don’t want to mess those things up because…
Your runway is shorter now than it was during the last crisis. On average, stocks experience a 10% selloff about once every year and 20% pullback every 3.5 years. The average time of recovery for the former is about 4 months. For the latter it takes about 22 months. So while my earlier point is absolutely true—markets have always recovered—you may not have enough time to wait it out. The closer you are to retirement, the closer you are to withdrawing money from your accounts. And if you’re taking distributions while the markets are down, your money won’t last as long. So use the current crisis as a not-so-friendly reminder to…
Focus on what you can control. John Wooden once said: “The more concerned we become over the things we can’t control, the less we will do with the things we can control.” It’s easy to focus on headlines, markets and political uncertainty, but we can’t really do anything about them so it’s an exercise in frustration. We can control things like saving, debt reduction, asset allocation, and risk management, however. Focusing on those actually produces results. Unfortunately, the bull market of the last six years has lulled many into a false sense of security. Use the current volatility to make sure that your portfolio is appropriate and your plans are on track.