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.
The amount of debt in the world is staggering.
- Auto loans recently passed $1 trillion for the first time and the average car loan is the highest it’s ever been, recently surpassing $30,000.
- Student debt stands at about $1.4 trillion.
- Mortgage debt is about $14 trillion.
- More than 30% of households carry a balance on their credit cards. Those that do have an average balance of $16,000
- The top 2,000 non-financial companies have $6.64 trillion in debt, $2.81 trillion of which they’ve added in the last five years.
- The U.S. public debt has nearly doubled since the 2008 financial crisis, ballooning from $10 trillion to more than $19 trillion.
- 20 years ago China had $500 billion in public and private and debt. Ten years ago that number stood at $3.5 trillion. Today it is more than $35 trillion.
More than the amount of debt, however, is just how much of it has been added since the 2008 financial crisis. After experiencing a debt induced financial Armageddon, you’d think individuals, companies and governments would be hesitant to go down that road again. Not so. Record low rates have fueled trillions (with a “T” like the Titanic) in new debt. It’s like eating until you’re sick at a buffet and then deciding that the next logical step is to grab a new plate and see how many cheese enchiladas and Mini BBQ Brisket sandwiches you can fit on it.
And just like binging at the buffet is likely to end badly, binging on debt will usually end in a combination of regret and real world consequences. How is all this debt affecting us and our ability to reach our retirement goals?
It’s causing stress. A recent survey of adults with student loan debt showed that people would go to some pretty extreme lengths to get rid of that debt. Nearly 57% would take a punch from Mike Tyson. More than 40% would give up a year of life expectancy. Almost 7% said they’d be willing to cut off their own pinky finger. Think about that. A not insignificant percentage of the borrowers polled would be willing to die sooner or hack off body parts if they could turn back time and get out from under their debt. Living with excessive debt is stressful.
It’s making us financially fragile. A recent Federal Reserve survey found that 47% of Americans could not cover an unexpected $400 expense without borrowing or selling something. In other words, half the country is stretched so thin that they couldn’t afford a car repair or a new pair of glasses without some sort of payment plan. There are likely many reasons for this state of affairs, but one is most assuredly debt. In other words, we need to go into debt to fund new purchases because all of our income is already being used to pay for the debts from our old purchases.
It’s limiting our ability to save for retirement. Each year the Employee Benefits Research Institute (EBRI) conducts a Retirement Confidence Survey to see how people are doing when it comes to saving for retirement. In the most recent survey, nearly a third of respondents reported having less than $1,000 saved so far. Two-thirds have less than $50,000 saved. You don’t need to be a financial genius to know that $1,000 is not enough to fund a 20 or 30 year retirement. Even $50,000 would only get you a year or two at best. Why aren’t we saving more? Again, one reason is debt. If most of your current money is being used to pay for past purchases, you won’t have much left over for future savings.
It’s exposing retirees to market risk. Even if you are near retirement and you have no debt, you may still be at risk from debt indirectly. That’s because, with interest rates so low, many retirees have been forced to move further up the risk spectrum to get any sort of yield on their investments. It used to be that you could put your money in a risk-free money market and earn 3%. Now those same investments pay 0%. Super safe bonds don’t yield much better, so many investors are shifting more of their portfolio to lower quality bonds or dividend paying stocks. That works fine while markets are rising, but if we get another debt shock and borrowers can’t repay, then markets could tumble and many investors may find that they took on too much risk in their search for yield.
How much debt is ok?
To be sure, not all debt is bad. Debt can be a useful tool when it’s used to purchase an asset or invest in a project that helps us to generate income and pay back the debt. That said, in order to retire comfortably, the typical person needs to move from a place of low savings and high debt early in their career to a place of high savings and low debt later in their career.
What should that gradual reduction look like? To help people track their progress, researcher Charles Farrell devised a Debt to Income Ratio and then established benchmarks for different age groups. According to Farrell, your debt (e.g. mortgage, car loans, credit cards, etc.) divided by your income should be 1.25 at 40, .75 at 50, .20 at 60 and zero at retirement.
Retiring debt free used to be the rule rather than the exception. Unfortunately, that is no longer the case. In fact, a recent study by the Employee Benefits Research Institute showed that 65 percent of American families with a head of household age 65-74 had debt. The age group with one of the biggest spikes in debt was 75 and older.
That’s troubling because debt adds risk and reduces cash flow, two things that can derail your retirement. It is inherently limiting at a time when most hope for greater independence and opportunity. It increases uncertainty at a time when most people want security. So make a plan to gradually eliminate your debt and you will greatly increase your odds of having freedom, flexibility and peace of mind during retirement.
“What could cause this to fail?”
That’s what I asked myself before heading to the Grand Canyon recently for a 47 mile, Rim to Rim to Rim hike with my friend Mike. The answer, it turns out, is “A LOT of things could cause it to fail.” In fact, there’s a 400 page book dedicated solely to detailing all of the deaths that have occurred in the canyon in modern times. I know because I read it. I wanted to see all the dumb, misguided, or sometimes just unlucky decisions people made that ended very badly so I could avoid those same blunders. I like adventure as much as the next guy, but priority #1 is coming home alive. Hence my question: What could go wrong and how can I avoid it? I call this process a Pre-Mortem.
You’ve likely heard of a Post Mortem. When someone dies, the medical examiner will often do a Post Mortem exam to determine cause of death. Similarly, when a project fails at work, the team responsible for said failure will often do a project Post Mortem to determine what went wrong. Post mortems can be helpful because people can learn from them and lessons can be used to avoid future mistakes.
The downside of a Post Mortem is the Post (after) part. Whatever it is you’re examining has already gone horribly wrong and the game is over. The opportunity is gone. Others can learn from your mistakes, but your chance is gone.
A better thing to do would be to do a Pre-Mortem. Instead of “Why did this fail?” ask yourself “What might cause this to fail?” Look at your own weak points and vulnerabilities. Examine other people who have failed doing something similar. What can you learn from them? How can you avoid similar mistakes or pitfalls?
The application to retirement is obvious. Retirement is a relatively short period of time when you hope to live a secure, exciting and fulfilling life. The problem is you’ve only got one shot at it and there are a whole mess of variables, any one of which could derail your plans. By doing a Pre-Mortem, you examine your unique situation and consider the most probable things that could cause your retirement to get sideways. Then you do everything you can to plan and prepare so those things either don’t happen or you’re well equipped to deal with them if they do. Result: Retirement goes off without a hitch.
What are some of the more common things that derail retirement?
- Running out of money
- Death of a spouse
- Health issues with you or a spouse
- No clear plans for what you want to do
- Lack of friends
- Depression/anxiety due to major life change
- Market crash
- Unexpected job loss
- Family issues (children, relative, etc.)
- Caring for elderly parents
- Living longer than you expected
- High debt or other poor financial decisions
- Health care costs
- Mistakes claiming Social Security
- Mistakes with your distribution strategy
Which are the most likely to trip up your plans? Think honestly about your life, your finances, your health, your family and your friendships. What things do you honestly see as the biggest potential threats to your retirement? What can you do to either prevent them or at least be prepared to deal with them if they arise? Spend some time thinking about this now and you’ll greatly improve your odds for a successful retirement.
By the way, the Grand Canyon hike went off without a hitch. Time to rest my feet for a while and start planning the next adventure.
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.
Have a great weekend!
Photo Credit: Jeremy Thompson. Used under Creative Commons License.
Quick Note: For those of you with “Retirement Planning” on your New Year’s Resolution list, I extended the $60 discount on The Ideal Retirement Design Guide through January 31st.
I have a retired client—let’s call him Mark—who was going on a trip and he asked his neighbor to water his plants and keep an eye on his house while he was gone. A year later, Mark was making a big purchase at a home improvement store and he decided to apply for a store credit card. His application was denied. This surprised him because he only had one other credit card which he hardly ever used and always paid in full. A little investigation revealed that he actually had five credit cards—four of which he knew nothing about and that were completely maxed out.
By now I’m sure you’ve guessed that his neighbor did more than water the plants. He dug through Mark’s belongings and pieced together information like his date of birth, Social Security number and mother’s maiden name and then started firing off credit card applications (American Express: Don’t leave your neighbor’s home without it.). He had the bills sent to his office address and always made the minimum payment. This meant that the accounts weren’t delinquent, but also meant that any potential day of reckoning was years away.
Anyone can be the victim of identity theft, but retirees are particularly vulnerable. They generally have good credit and available resources (they’re retired after all), both of which can be tempting targets for thieves. Not only that, but our memory can diminish as we age, a situation that criminals are more than happy to try to exploit. So what exactly is identity theft and how can you protect yourself or a loved one? What should you do if someone steals your identity? Are you liable for any fraudulent debts? How can you clear your name?
What is identity theft?
Identity theft is when someone uses your personal information to fraudulently do things like take out a loan, obtain I.D., open a credit card or gain access to your bank accounts.
Criminals use a number of tricks in their efforts to gain access to your personal information. They steal mail, go through your personal belongings (like Mark’s neighbor), scour the Internet for personal information, send “Phishing” emails and hack into computers to name a few.
The longer a criminal is using your identity, the more damage he can do, so it’s important to keep your eyes open for certain red flags such as money missing from your accounts, calls from debt collectors about debts you know nothing about, unusual charges on your credit card statements or denial of credit. Any of those could indicate problems.
What should I do if my identity is stolen?
As I mentioned earlier, it’s important to act quickly if you find a problem. Begin by placing a fraud alert on your credit report with the different credit bureaus. This will prevent thieves from causing further damage by opening new accounts. You can do this by phone or at their websites:
Once you notify one agency, they are required to notify the others. The fraud alert will last for 90 days, but for more severe cases you can extend that to seven years by filing additional paperwork. After notifying the agencies, download a free copy of your credit report and go through it to identify any fraudulent activity or inaccurate information.
Next, file a police report and obtain a copy that you can use to verify your claims as you work to fix the problems caused by the theft. In addition to the police report, file a complaint with the Federal Trade Commission (FTC). They maintain a large identity theft database which they use to assist law enforcement and affected companies with identity theft investigations. You can file a complaint at www.consumer.gov/idtheft or by calling 1-877-438-4338. One of the forms they will have you fill out will be the Identity Theft Affidavit, which you can use with affected companies to begin fixing any problems.
Once you have filed the fraud alert, the police report, the FTC report and identified the affected accounts, contact each company holding those accounts so you can notify them of the fraud and have the accounts frozen and closed. If your bank account or credit card was affected, you will need to open new accounts. Be sure to update your passwords or personal identification numbers in case those were also compromised. Once you have the problems fixed, it’s a good idea to work with the credit bureaus to clean up your credit report by having any entries related to the fraud removed from your report.
Am I liable for the fraud?
One of the first questions people often have when it comes to identity theft is “What am I liable for?” The answer depends on what form the fraud took and how quickly it is reported. You are generally responsible for $50 per card in unauthorized credit card transactions as long as you report the fraud within 60 days of receiving the bill with the fraudulent charges. Debit cards are a bit more stringent. You have only 2 days to report unauthorized withdrawals or transfers to maintain the same $50 limit of liability. Anything between 2 and 60 days will likely mean you’re responsible for up to $500 in unauthorized transfers. Anything beyond that and you risk losing the money. Not only do debit cards have a tighter reporting window, but you will also likely be without the money that was stolen until the bank can straighten things out. For those reasons, it may be worth choosing your credit card over your debit card when making purchases.
What can you do to protect yourself from identity theft?
There are several things that you can do to make it difficult for thieves to steal your identity. First and foremost, keep a tight rein on all of your personal information (e.g. Social Security number, date of birth, etc.). If you’re making online purchases or using online banking, make sure that you use strong passwords and that your computer has all of the latest security updates downloaded and installed. Run regular scans to detect any viruses or malware.
You can also place a security freeze on your credit report which will prevent credit agencies from releasing any information when they receive requests from banks or credit cards without first getting your authorization. As a result, any unauthorized application or request for a new account gets denied because the company can’t obtain the information it needs.
Finally, you might also consider signing up for a service like LifeLock to help you monitor your credit and notify you of any suspicious activity. These companies will also help fix any damage done by identity thieves. A paid service can be a good option (and give you peace of mind) if you are ever the victim of a large breach (e.g. Target stores, the Chinese hacking breach of the Office of Personnel Management, etc.) and want to keep a an eye out for anyone trying to misuse the compromised data.
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.