Curious Cat Investing and Economics Blog » Financial Literacy

More Than Half of Those in the USA are at Risk of Not Saving Enough for Retirement

John Hunter — Sun, 28 Dec 2014 15:28:47 +0000

The Center for Retirement Research at Boston College is a tremendous resource for those planning for, or in, retirement. The center created the National Retirement Risk Index (NRRI) to capture a macroeconomic level measure of how those in the USA are progressing toward retirement.

Based on the Federal Reserve’s 2013 Survey of Consumer Finances the Center updated the NRRI results (the entire article is a very good read).

The NRRI shows that, as of 2013, more than half of today’s households will not have enough retirement income to maintain their pre-retirement standard of living, even if they work to age 65 – which is above the current average retirement age – and annuitize all their financial assets, including the receipts from a reverse mortgage on their homes. The NRRI clearly indicates that many Americans need to save more and/or work longer.

from the NRRI report.

The lower the risk number in the chart the better, so things have not been going well since the 1990s for those in the USA saving for retirement.

As the report discusses their are significant issues with retirement planning that defy easy prediction; this makes things even more challenging for those saving for retirement. The report discusses the difficulty placed on retirees by the Fed’s extremely low interest rate policy (a policy that provides billions each year to too-big-too-fail banks – hardly the reward that should be provided for bringing the world to economic calamity but never-the-less that transfer of wealth from retirees to too-big-to-fail banks is the policy the Fed has chosen).

That exacerbates the problems of too little savings during the working career for those in the USA. The continued evidence is that those in the USA continue to spend too much today and save too little. Also you have to expect the Fed and politicians will continue to make policy that favors their friends at too-big-fail banks and hedge funds and the like. You can’t expect them to behave differently than they have been the last 50 years. That means the likely actions by the government to take from median income people to aid the richest 1% (such as bailing out the bankers with super low interest rate policies and continue to subsidize losses and privatize their winning bets) will continue. You need to have extra savings to support those policies. Of course we could change to do things differently but there is no realistic evidence of any move to do so. Retirement planning needs to be based on evidence, not hopes about how things should be.

The Importance of Long Term Disability Insurance

John Hunter — Wed, 03 Dec 2014 16:03:32 +0000

Insurance can be annoying as you pay for something you hope not to use. I don’t recall ever getting a payment on life insurance, homeowners insurance, disability insurance or auto insurance. And that I haven’t had a claim is good. On health insurance I have had minor things covered like a physical or dentist and that is it.

Health insurance is critical in the USA. One insurance that people often don’t think of however is disability insurance. It is very

Disability insurance is a very important insurance that too many people don’t consider (many jobs offer it, though not all, and some may take a year before you are covered). Studies show that a 20 year old has a 30% chance of becoming disabled before reaching retirement age. In the USA, the Social Security Administration provides disability benefits for total disabilities.

In the USA you may be eligible for social security disability payments but it is a small amount (so not sufficient by itself). But if you are living overseas and not paying social security I am not sure if you are covered, even for the limited coverage it provides.

I am not sure what the situation is for citizens of other countries, maybe they have better safety nets for people (I would imagine Europe does, but many places probably don’t).

I had been living in Malaysia for several years and am now going nomadic (an increasingly popular choice for a small but determined group of people) and insurance is important for people living overseas and traveling. For nomads or frequent travelers global health insurance is good (though usually it will exclude the USA if you are not a “USA 1%er”(or world .2%)/very-rich as the extremely broken USA health care system is crazy – you can be covered globally excluding the USA for about 1/6 of that same coverage excluding the USA, depending, of course on your coverage). Special care for travelers and nomads should be paid to coverage to return you home if you are very sick or injured.

Disability insurance is something thing digital nomads should pay attention to. But it is normally ignored. And it is a bit tricky as insurance companies are generally extremely slow to catch up to what the world is doing and disability insurance seems to be stuck in the old notions about how tied people were to one country (as are other things – demanding physical addresses even if they know you are nomadic…, basing rules on silly ideas about where you happen to be at some point in time with customer hostile breaking of internet services that have been paid for etc.).

International Migrants: Economics and Banking

John Hunter — Wed, 15 Oct 2014 16:52:12 +0000

In 2013, international migrants sent $413 billion home to families and friends — three times more than the total of global foreign aid (about $135 billion). This money, known as remittances, makes a significant difference in the lives of those receiving it and plays a major role in the economies of many countries.

India received $72 billion and Egypt $18 billion in 2013.

I liked an interesting point he made. These remittences often include business advice to those relatives in the home country.

This is a great talk if you are interested in economics and global development. It is very important to understand the issues we face in helping billions living in poverty. As he says regulation of small remittences must be reduced. Policies forced by countries like the USA have damaged poor people’s lives worldwide with extremely onerous regulation.

Web site of the speaker: Dilip Ratha

Debate Should be Encouraged – Calling Judgement “Extremely Paternalistic” is Normally Unwise

John Hunter — Tue, 30 Sep 2014 16:15:59 +0000

My response to a comment by John Green on Reddit

I really really like your work and webcasts (example included below).

It seems to me extremely paternalistic for people in rich countries to claim to know what is best for people in poor countries

This seems to me to make it really difficult on people trying to use judgement. Calling people’s actions “extremely paternalistic” if they are not definitely so, I think impedes debate. And I think debate should be encouraged.

When making Kiva loans I do steer away from loans with rates above 40% (I also prefer loans that are geared toward a capital investment that will increase earning power going forward though this is hard – lots of loans are essentially for inventory that will be sold at a profit so a fine use of loans but not as powerful [in my opinion] and new capital investments – say a new tool, solar power that will be resold to users…).

Just like people anywhere, people taking Kiva loans are capable of getting themselves into trouble. Choosing to allocate my lender toward certain loans does not mean I am being paternalistic.

I am not being paternalistic if I chose not to invest in the stock of some company that vastly overpays executives and uses high leverage to do very well (in good times).

I do like the idea of direct cash to people in need. I give cash that way (and in fact did it a long time ago, 20 years, for several years – before any of this new hipster cachet :-). And I still do like it.

I also like to give to things that I think are good where I decide what the money will be spent to invest in (I like Global Giving). I have also been giving to Trickle Up for more than 20 years. They, to simplify, give micro grants (so not loans) to extremely poor to build businesses. I believe that there is great value in helping people gain long term economic success (even if that isn’t exactly the way they would use the funds if they had free reign). I don’t think that is paternalistic.

Declaring that if someone wants to borrow at an 80% interest rate that it is paternalistic to question that decision I think is unfair. To say the borrower knows best and if they think 80% is good that should be good enough is fine. I am not sure I agree (I think with rates that high it is possible wise, but the risks become greater and the borrower needs to be more aware of the risks), but I agree it is possible.

I like your later statement much more: “The reality of global poverty IS messy and complicated, and I do think there are times when kiva fails to acknowledge the complexity.” I think you understand the complexity and the reason why paying rates that seem very high may well be in the person’s best interest.

I think in this context “paternalistic” quickly gains connotations of racism (knowing better than those others…). It isn’t children we are talking about so being called paternalistic in relations to adults that are often of another ethnicity can easily push in that direction.

I also think it is sensible to object to payday loans in the USA. You could make the same argument that such an attitude is paternalistic (though I do see in your comments the explanation of the understanding of how limited the loan options are for many overseas – though that is how it can feel to many in the USA that use payday lenders).

The Time to Payback the Investment in a College Education in the USA Today is Nearly as Low as Ever – Surprisingly

John Hunter — Tue, 23 Sep 2014 15:46:38 +0000

While people question the value of a college degree a recent study by the New York Federal Reserve shows a degree is close to as valuable today as it has ever been. The costs to get that value have risen but even with the increased cost students earn on average a 15% annual rate of return on their investment.

Of course, not every student will earn that, some will earn more and some less.

The Value of a College Degree

We estimate that the value of a college degree fell from about $120,000 in the early 1970s to about $80,000 in the early 1980s, before more than tripling to nearly $300,000 by the late 1990s, where it has remained, more or less, ever since. Despite drifting down somewhat in the aftermath of the Great Recession, the value of a bachelor’s degree has remained near its all-time high.
…
The time required to recoup the costs of a bachelor’s degree has fallen substantially over time, from more than twenty years in the late 1970s and early 1980s to about ten years in 2013. So despite the challenges facing today’s college graduates, the value of a college degree has remained near its all-time high, while the time required to recoup the costs of the degree has remained near its all-time low.

So a college education is a great investment for most people. This can create a problem however, when people then assume that all they need to do is go to college and they will do well no matter what. The same thing happens in other markets. Real estate has proven to be a great investment. that doesn’t mean every real estate investment is good. It doesn’t mean you can ignore the costs and risks of a particular investment. The same goes for stocks.

In education there is a sensible case to made that the more people getting degrees the more risky it is. If very qualified people get degrees and that is limited to 10% of the population it isn’t hard to imagine those people will do well. Partially if they are selected somewhat effectively based on merit and potential (lets just say that it works out to 50% of the top 20% of the population for capability and potential) they would do well even if all you did was select them for college and nothing else (they never went to college).

Now if you start getting to the people with the 50th to 60th percentile capability and potential there is a reasonable case that these people are less likely to thrive economically. So if the costs of college for them are just as high as those in the top tenth percentile it is reasonable to expect they may take longer to pay it back or fail to do so.

I believe this is more a thought experiment than something to definitively measure. I think you can classify people to some degree by merit and capability but it is a measure prone to much error. Over large population however I think it is possible.

Another point is while I can imagine the payoff for college would be lower for people below the 50th percentile of this made up merit and capability measure it may be this expectation is just wrong. Maybe those people would benefit economically just as much or maybe even more. Some data could be collected on this (and I imagine is). I imagine it is not studied too much as there would be lots of political incorrect baggage about data showing people on some measures have less potential to earn back the costs of higher education.

I question for example the benefit of many of these for-profit “education” organization that seem much less focused on education and much more focused on their profit. Frankly I am very disappointed with the lack of education focus at those schools we think of as the best of the best. These schools often seem to lose themselves in vanity ego projects, hiding intellectual advances behind pay-walls and other bad practices.

But taking all the failures of these schools into account I am much more worried about others taking advantage of students to encourage unrealistic expectations about taking on debt for students that are less capable or even interested in academic pursuits.

Still for those with reasonable capability and interest the Fed study shows the payoff of education is still strong. It is sad that the costs have risen so much (again due in large part to the actions of educational institutions focusing on playing to the leaders egos instead of focusing on education for students at a reasonable cost). But even with the poor management by education leaders making the burden on students higher taking on that burden is wise for most students.

A second post by the Fed looks at that question: College May Not Pay Off for Everyone

Measured at the medians, the wage premium for a bachelor’s degree has generally hovered between 60 and 70 percent since the 1990s. As we have cautioned before, this earnings gap may arise at least in part from differences in the skills and abilities of those who earn a college degree compared with those who don’t, rather than from the knowledge and skills acquired while in college.

However, when we look at wages for the 25th percentile of college graduates, the picture is not quite so rosy. In fact, there is almost no difference in the wages for this percentile ranking of college graduates and the median wage for high school graduates throughout the entire period. This means that the wages for a sizable share of college graduates below the 25th percentile are actually less than the wages earned by a typical worker with a high school diploma.

While we can’t be sure that the wages of this group wouldn’t have been lower if they had never gone to college, this pattern strongly suggests that the economic benefit of a college education is relatively small for at least a quarter of those graduating with a bachelor’s degree.
..
once the costs of attending college are considered, it is likely that earning a bachelor’s degree would not have been a good investment for many in the lowest 25 percent of college graduate wage earners.

I made the last sentence bold.

Update, study finds: “The marginal admission yields earnings gains of 22% between 8 and 14 years after high school completion. These gains outstrip the costs of college attendance, and they are largest for male students and free-lunch recipients.”

Companies Trumpet Stock Buybacks and Act as Though Stock Givaways Don’t Matter

John Hunter — Wed, 27 Aug 2014 16:55:37 +0000

One of the things that annoy me as an investor is how happy the executives are to grant themselves huge amount of pay in general and stock in particular. The love to giveaway huge amounts of stock to themselves and their buddies and then pretend that isn’t a cost.

Thankfully the GAAP rules changed a few years ago to require making the costs of stock giveaways show up on official earnings statements. Now, the companies love to trumpet non-GAAP earnings that exclude stock based compensation to employees.

The stock based costs are huge.

SG Securities estimates that corporates bought back $480 billion in stock last year, and then reissued about $180 billion.

The theme of the article is that stock buybacks have declined drastically very recently. There has been a huge bubble recently fueled by the too-big-too-fail bailout (quantitative easing). But don’t expect the executives giving themselves tons of stock to decline.

Accounting isn’t as straight forward as people who have never looked at it would like to think. While giving away stock is definately a cost, it isn’t a cash cost. The cash flow statement is best for looking at cash anyway. And the better your company does the more the free spirited giveaway of stock costs (both in your reduced share of the well performing company and the higher cost to buy back the shares they gave away).

They have excuses that they hire people who are not motivated enough to do their job for their pay so they need to offer stock options as a extra payment. But the main reason they like it is they can pretend that the pay to employees isn’t costing as much as it is because we gave them stock options not cash. As if paying $1 billion in cash is somehow more costly than giving away options and then spending $1 billion on buybacks of the stock they gave away.

Options make a lot of sense for small private companies. In a very limited way they can make sense as companies grow. But the practices of executives in huge bureaucracies giving away large amounts of your equity, on top of huge paychecks, is very harmful.

Related: Apple’s Outstanding Shares Increased from 848 to 939 million shares from 2006 to 2013 (while I think Apple’s large buyback is good, the huge share giveaways continue and are bad policy) – Google is Diluting Shareholder Equity by 1% a year (2009-2013) – Executives Again Treating Corporate Treasuries as Their Money

Index Fund Beats Hedge Funds

John Hunter — Mon, 11 Aug 2014 16:08:29 +0000

Hedge funds seek to pay the managers extremely well and claim to justify enormous paydays with claims of superior returns. Markets provide lots of volatility from which lots of different performances will result. Claiming the random variation that resulted in the superior performance of there portfolio as evidence the deserve to take huge payments for themselves from the current returns is not sensible. But plenty of rich people fall for it.

As I have written before: Avoiding Hedge Fund Investments is One of the Benefits of Being in the 99%.

This is pretty well understood by most knowledgeable investors, financial planners and investing experts. But funds that charge huge fees continue to get away with it. If you are smart you will avoid them. A few simple investing rules get you well into the top 10% of investors

seek low fees
diversify – pay attention to risk of portfolio overall
limit trading (low turnover)
use tax advantage accounts wisely (in the USA 401(k)s and IRAs)

From a personal finance perspective, saving money is a key. Most people fail at being decent investors before they even get a chance to invest by spending more than they can afford and failing to save, and even worse going into debt (other than to some extent for college education and house). Consistently putting aside 10-20% of your income and investing wisely will put you in good shape over the long term.

Warren Buffett put his money (a tiny bit for him, just $1 million) on the idea that hedge funds can’t outperform the market given the huge fees they charge. After 6 years he is well up on his bet with his pick (Vanguard S&P 500 index soundly beating a portfolio of hedge funds selected by the opponent in the bet).

I do wonder at what point the huge amount of index investing creates opportunities that can be exploited profitably. I actually think that point has been passed. The question now is can you profitably and reliably find active investing managers that are wise and charge relatively low fees? Passive investing may now account for over 60% of investments in the market.

Also in certain market environments where the market is likely to ignore useful data (bubbles or fads) or where data is questionable and smart digging can provide useful and profitable insight (China may fit this idea now – I pay for actively managed Templeton developing market funds and have for 20 years, I also have Vanguard developing market index type fund – VWO). I think most investors should primarily use index funds (REITs, etc.) but I think the prospects for investors picking their own stocks may be better as more investing is based solely on index funds mass buying and selling.

I am worried about the price level of the overall market now. I am less worried about some stocks; this means I am more comfortable holding Apple, Google, Toyota, Abbie etc. (not so much – Amazon) than I am the S&P 500 right now.

Cockroach Portfolio

John Hunter — Wed, 12 Feb 2014 04:47:07 +0000

Dylan Grice suggests the Cockroach Portfolio: 25% cash; 25% government bonds; 25% equities; and 25% gold. What we can learn from the cockroach

Each of those asset buckets protects against a different type of risk. And that is a very sensible approach to investing in the year ahead. Cash will protect you against a market collapse in anything (provided it’s cash held with a solid institution).

Government bonds protect against deflation (provided your money’s invested in solid government bonds and not trash). Equities offer capital growth and income. And gold, as we know, protects against currency depreciation, inflation, and financial collapse. It’s vitally important to maintain holdings in each, in my opinion.

The beauty of a ‘static’ allocation across these four asset classes is that it removes emotion from the investment process.

I don’t really agree with this but I think it is an interesting read. And I do agree the standard stock/bond/cash portfolio model is not good enough.

I would rather own real estate than gold. I doubt I would ever have more than 5% gold and only would suggest that if someone was really rich (so had money to put everywhere). Even then I imagine I would balance it with investments in other commodities.

One of the many problems with “stock” allocations is that doesn’t tell you enough. I think global exposure is wise (to some extent S&P 500 does this as many of those companies have huge international exposure – still I would go beyond that). Also I would be willing to take some stock in commodities type companies (oil and gas, mining, real estate, forests…) as a different bucket than “stocks” even though they are stocks.

And given the super low interest rates I see dividend paying stocks as an alternative to bonds.

The Cockroach Portfolio does suggest only government bonds (and is meant for the USA where those bonds are fairly sensible I think) but in the age of the internet many of my readers are global. It may well not make sense to have a huge portion of your portfolio in many countries bonds. And outside the USA I wouldn’t have such a large portion in USA bonds. And they don’t address the average maturity (at least in this article) – I would avoid longer maturities given the super low rates now. If rates were higher I would get some long term bonds.

View of Glacier National Park, from Bears Hump Trail in Waterton International Peace Park in Canada, by John Hunter

These adjustments mean I don’t have as simple a suggestion as the cockroach portfolio. But I think that is sensible. There is no one portfolio that makes sense. What portfolio is wise depends on many things.

I think something along the lines of this would make sense today for someone living in the USA (but I would vary it a fair bit depending on the person’s situation and it would change in different market conditions)

35% Total Stock Market Index Fund (VTSMX)
15% Total International Stock Index Fund (VGTSX)
10% Vanguard emerging markets fund (VWO), or something similar
20% high quality “dividend aristocrat” type stocks
10% REIT Index Fund (VGSIX) or direct real estate ownership
5% bonds
5% cash

I would likely go a bit higher for real estate with direct ownership. As the portfolio was approaching the time withdrawals would be made (retirement) I would want real estate investments to be substantially cash flow positive (and leverage to be limited – hopefully under 50%). I would like primary residence to be without a mortgage or with a very small mortgage.

If I was drawing substantial income from the portfolio I would likely increase cash to at least 3 years of projected need (though even this gets a bit fuzzy as adjusting for expected interest and dividends makes sense to me).

I’m willing to include dividend stocks that don’t meet the dividend aristocrat rules but are similar: (ABBV, INTC even AAPL). I would consider including a bit in pipeline MLPs such as OKS (higher current yields but likely less growth).

Google is Diluting Shareholder Equity

John Hunter — Wed, 08 Jan 2014 14:40:05 +0000

Many companies that have have plenty of cash chose to dilute stockholder equity instead of paying market rate salaries. They also do this to pay more than they would be willing to if they had to pay cash and take a direct earnings hit officially and unofficially. And they may do it to allow employees to delay paying taxes (I am not sure if this plays a part or not) – and maybe even avoid taxes using some financial games. Companies chose to give away stockholder equity under the pretense that those losses to shareholders can be hidden on financial statements (and they often are).

Thankfully SEC rules forced disclosure of such financial games in the last few years. Still “Wall Street” often promotes the earnings which pretend though employee costs that are paid with stock instead of cash are not costs to the business.

Google is cash flow positive by billions every quarter. Yet they have issued over 1% more stock each year.

Outstanding share balances in millions of shares

Sep 30 2013	Dec 31 2012	Dec 31 2011	Dec 31 2010	Dec 31 2009
334.2	330	324.9	321.3	317.8

This means Google has given away over 5.2% of a shareholder’s ownership from January 1, 2010 to September 30, 2013. If you owned 100 shares at the end of 2010 you owned .000315% of the company. At the end of the period your ownership had been diluted to .000300% of the company.

When the stock value is rising rapidly (as Google’s has) it proves to be much more costly than if the company had just paid cash in the first place. In Google’s case you would own 5% more of the company and the cash stockpile Google had would be a bit lower (Google had $56,523,000,000 in cash at the end of Sep 2013).

For companies that don’t have cash (startups) paying employees with stock options makes sense. When companies have the cash it is mainly a way to hide how much the company is giving away to executives and to provide fake earnings where only a portion of employee pay is treated as an expense and the rest is magically ignored making earnings seem higher.

Lazy Golfer Portfolio Allocation

John Hunter — Fri, 13 Dec 2013 03:48:50 +0000

There are many asset allocation strategies; which often are pretty similar. In general they oversimplify the situation (so an investor needs to study and adjust them to their situation – though most don’t do this, which is a problem). In general, I think asset allocation suggestions are too heavily weighted on bonds, and that is even more true today in the current environment – of could that is just my opinion.

I ran across this suggested allocation in Eyewitness to a Wall Street mugging which I think has several good values.

It focuses on low fee, market index funds. Fees are incredibly important in determining long term investment success
It has lower bond allocation than normal
It has more international exposure than many – which I think is wise (this suggested portfolio is for those in the USA, USA portion should be lowered for others)
It includes real estate (some suggested allocations miss this entirely)

In my opinion this allocation should be adjusted as you get closer to retirement (put a bit more into more stable, income producing investments).

My personal preference is to use high quality dividend stocks in the current interest rate environment. I would buy them myself which does require a bit more work than once a year rebalancing that the lazy golfer portfolio allows.

I would also include 10% for Vanguard emerging markets fund (VWO) (for sake of a rule of thumb reduce Inflation Protected Securities Fund to 10% if you are more than 10 years from retirement, when between 10 and 1 year from retirement put Inflation Protected Securities Fund at 15% and Total Stock Market Index Fund at 35%, when 1 year from retirement or retired lower emerging market to 5% and put 5% in money market.

Depending on your other assets this portfolio should be adjusted (large real estate holdings [large net value on personal home, investment real estate…] can mean less real estate in this portfolio, 401k holdings may mean you want to tweak this [TIAA CREF has a very good real estate fund, if you have access to it you might make real estate a high value in your 401k and then adjust your lazy portfolio], large pension means you can lower income producing assets, how close you are to retirement, etc.).

The Lazy Golfer Portfolio (Annually rebalance the fund on your birthday and ignore Wall Street for the remaining 364 days of the year) contains 5 Vanguard index funds

40% Total Stock Market Index Fund (VTSMX)
20% Total International Stock Index Fund (VGTSX)
20% Inflation Protected Securities Fund (VIPSX)
10% Total Bond Market Index Fund (VBMFX)
10% REIT Index Fund (VGSIX)