Market Reaction to Trump

This from Yahoo Finance, "How Wall Street is trying to make sense of the stunning stock market rally" 

Stock prices crashed as it became clear that Donald Trump would be elected the next President of the United States. And then they did a complete reversal to actually rally during the first trading day after the votes were counted.Just when you thought the stock market was starting to make sense, it goes ahead and does the exact opposite.The markets were supposed to get crushedAhead of Election Day, Wall Street’s stock market experts were in broad agreement that a surprise victory by Republican candidate Donald Trump would be met by a sharp sell-off, ranging somewhere between -3% to -15%. Yahoo Finance reported on this multiple times.

This is another example of the futility of trying to time the market. There also is some "recency bias" apparently going on. This is where investors give weight to what has happened in similar situations in the recent past. On this front not long ago investors saw the head fake from the Brexit situation whereby stocks dropped and then reversed sharply. 

Market time at your own risk.

Can you find a growth fund that will return 12% over the long term?

Debt elimination guru Dave Ramsey argues that people should eliminate all debt and then invest in a growth fund that returns 12%/year. By the rule of 72 money doubles every 72/12 = 6 years. Sweet!

I, with just about everyone who is familiar with Ramsey, admires his work on the debt side. He has helped thousands get out of and stay out of debt.

But his investment advice is misleading and potentially harmful. Finding a Fund that averages 12% over the long term is like trying to find the next triple crown winner. Good luck! And as he further recommends taking 8%/year out of your nest egg can lead to the outcome that is most feared by retirees - running out of money.

Actually, people don't tend to run out of money - they tend to run out of lifestyle. Draw down at too great a rate and one morning you wake up and realize you can't visit the kids as often, you can't eat out as often, and (drat it!) you have to ask your boss at Wal Mart if you can get more hours!

But the good thing about living in the internet age is that it is fairly easy in most instances to research claims or for that matter just about anything you are interested in. People do this in many areas but not so much in finance.

For example, Google "Large Company Stock Returns" and you'll come up with a link that shows the following table:



This table is reported by Kiplinger and the data comes from Morningstar. These Funds are the top performers out of tens of thousands of Funds.

Looking under the 10 year and 20 year columns you see no 12% s. As you do your research you'll find that Ramsey uses the non sensical arithmetic average whereas the appropriate average is a compound annual number.

But the idea here extends beyond Dave Ramsey and his investment advice. Suppose you want to know what Warren Buffet suggests as an investment approach for the average investor. Or, you have an annuity and, like most people including those who sell them, you can't make heads nor tails of it. Just go on a good search engine and look them up.

Doing the research ahead of meeting with professionals is especially useful because once the jargon starts flying the will weakens and when it comes to financial products people just give in. To hammer this home think of going in to meet with an attorney to discuss setting up a donor advised fund. If you are like most people you may be a bit intimidated in meeting with an attorney. Do a little research and this stress will be reduced and you'll be able to follow the pros and cons as presented and in the end be able to make a better decision. It is all a benefit of living in the information age.

Grant Cardone Shuns 401 (k)

Grant Cardone gave an interview on CNBC trashing the 401 (k) as a savings vehicle, "Self-made millionaire: Don't put money in your 401(k)".

If you're like me you're wondering "who is Grant Cardone"? Google his name and you find that he is a motivational speaker, specializing apparently in teaching people how to sell. In other words, he is a self promoter. If the thought is crossing your mind that we have too much self promoting already we are on the same page.

Mr. Cardone claims he made his first million at the age of 30. He was 30 years old in 1988. For the record, if he had $1 million in a 401(k) back then, invested in the S&P 500, today it would be worth approximately $8 million ( (1.07864 ^ 28) * $1.0 million).

I'm sure he is worth considerably more and could probably easily find out by buying the book he is promoting. I'm sure in his mind he can take people off the street and turn them into millionaires using his sales techniques.

All of this of course is quibbling about hypotheticals in my view. What I do have a problem with is the message to stay away from the 401(k) and try to become a millionaire. The planet is littered with people who have tried and failed and have no back up.

Look at like this. Kids spend the summer lifting weights, throwing a football through a tire and running wind sprints. Then the fall comes and the tryouts for quarterback are upon them and only one gets to be the starting quarterback. Similarly, kids take dance lessons, singing lessons etc. and then the tryout for the lead in the school play is held. One person gets it.

There is only one Tom Brady. Telling people to forget the 401(k) and seek a fortune by starting a business is like counseling a high school quarterback to try and become a low draft pick and be the next Tom Brady. I suggest having a back-up plan just in case.

Mr. Cardone states, "Why would I go to work, have my employer give me another $6,000 a year, and then take that money and send it off to Wall Street, where I can't even touch it for 30 years? 

The answer is pretty straight forward: because by doing so you are investing in the greatest wealth creating economy the world has ever known in the beginnings of the information age betting on entrepreneurs creating products we cannot even begin to imagine. To most people this makes sense when they realize that the day is coming when they will be 65 years old.

Can't Save? Think Again.

Probably the number one excuse for not saving for retirement is that people need every single penny of their paycheck. Most of us have been there and done that. This isn't just at the lower end of the economic spectrum but admittedly is most prevalent there. At least that's the most frequent response I get from people. The "I can barely make ends meet as it is, how am I supposed to make contributions to a 401(k) or an IRA " is a frequent refrain.

But the fact of the matter is people are already saving. It is forced saving. Out of every paycheck 7.65% is deducted for Social Security and Medicare. Think about this. If this was a choice I would be willing to make a sizable bet that many people would opt out and take the 7.65% each paycheck. Clearly this would exacerbate the retirement crisis that is building in this country. Sadly, many people have to be coerced into doing what is good for them.

To hammer home the idea imagine the task of trying to find people, especially as you move down the economic spectrum who don't welcome with open arms their monthly Social Security payment.

As you think about this you realize that this retirement payment is made through the years as you pay off your student debt, take on a house mortgage, have medical problems, have car payments, consider college for the kids etc. In other words, through all the usual excuses for putting thinking about retirement on the back burner.

An important corollary to all of this is that saving is more important than market returns in building a retirement nest egg, especially in the beginning. But many people use the uncertainty of the capital markets as an excuse to shy away. Know this: saving dominates. In fact, as is widely stated savers who are building a nest egg should cheer a negative stock market which gives them an opportunity to buy in at more attractive prices.

Is This an Accumulator or a Decumulator Market?

In the simplistic world of financial planning you fall into one of three categories: an accumulator building a nest egg, a decumulator drawing down your nest egg and a live for today, borrow and spend type who will worry about retirement when it gets here. For the record there are too many in this latter category.

All three show up on the investment manager/financial planner's doorstep and the fact is only the first two can be helped unless the live for today person has had a revelation and has years to go before they want to build a nest egg or happily has been the beneficiary of an inheritance, won the lottery etc.

So what about the market for the accumulator and decumulator categories? Here are some market indices as reported by Schwab in their performance module. The returns are thru the close of business on 10/14/2016:

Market Index        3 months     YTD     1 year     5 years
S&P 500               -0.9              6.17       9.30       14.15
MSCI EAFE          1.22           -.47        -1.05        5.56
Russell 2000          1.21           8.01        8.25       12.77
Barclay's Bond     -0.50           5.08        3.84         3.10
Citi 3-mo. TB        0.07           0.20        0.21         0.08
S&P GSCI             1.60           7.72     -11.53      -13.54

Note that the 5 year number is an average annualized return. The S&P GSCI is an index of commodities produced by Goldman Sachs. The Citi 3-mo. TB (Treasury bill) return is a proxy for cash equivalent investments.

From one perspective the returns have been good for both the accumulator and the decumulator. They have been good for the accumulator because positive returns keep people in the market. On the other hand positive returns means the market is getting more pricey and sometimes gets investors to take more risk than they should. Accumulators would actually be better off if the returns were negative because then they could pick up shares at a lower price and the probability of strong returns going forward would be greater.

Decumulators should be more than satisfied with these returns as long as they stayed away from commodities, didn't park their retirement assets in cash and followed a well conceived asset allocation/drawdown strategy. Most decumulators are retirees. The behavior of markets for the first several years of retirement are critical. The 65 year old who retired 5 years ago is today 70 years old - by the "rule of 72" the annualized 14.15% return on equities has doubled money in the stock market. A retiree could hardly ask for more! Most will find that they took a nice drawdown and today have more than they started with 5 years ago and yet are 5 years closer to the grim reaper.

What more could they ask for?

A Big Mistake

Over 20 years ago the bank I worked at was taken over by another bank. Companies are bought and sold all the time. This of course raises the stress level of employees, rumors swirl on who will be let go and who will stay. There is talk of promotions and everyone is focused on a potential reorganization and possible physical move. If you've been through this you know what I mean.

One of the outcomes typically is a short notice from Human Resources informing employees that the 401(k) will be terminated and that the employee has a number of options. They can roll over into the new company's 401(k), they can roll over to an IRA with a broker like Schwab or Vanguard, or they can can paid out a lump sum. Getting paid out a lump sum typically involves a penalty and income taxes.

The big mistake is taking the lump sum. Unfortunately, I saw most lower income employees seeing it as some type of windfall. Visions of a happy holiday season danced in their heads. They were happy to get this opportunity to take the lump sum distribution.

But look at the situation. Suppose an employee back then had $20,000 in his or her 401(k). Let's suppose the employee was 35 years old. They take it as a lump sum payment and pay a 10% early withdrawal penalty of $2,000 and income taxes of roughly 20% say so they get a check for $14,000. Wow! Happy dance time.

But fast forward 20 years and note that over the period a conservatively allocated 65% stock/35% bond portfolio more than quadrupled. The $20,000 today would be worth more than $80,000! The employee is now 55 years old and possibly faces retirement within 10 years - meaning that the $80,000 can potentially tack on quite a bit more. By the rule of 72 the portfolio only needs a return of 7.2%/year on average to double in 10 years.

This is a mistake that comes in many guises. Whenever there is a sum of money lying around there is a temptation to take it. It is like the person who is trying to quit smoking but just can't as long as there is cigarette nearby.

But time goes by and one day we'll all be facing that 65 year old birthday and then mistakes or not will be obvious.

How's the Market Doing?

When asked about how the market is doing people tend to respond with "it's pretty much going sideways".  Really?

Mostly they focus on stocks which is understandable since stocks are the most volatile component of the markets over the short term. Still I think it is more appropriate to look at markets from a broader perspective.

For example, many investors follow an allocation of roughly 60% stocks/40% fixed income (bonds) and cash. This is a pretty conservative allocation even for those at the beginning of their retirement.

Here is Schwab's model for this particular allocation:

35% Large Cap Equity
10% Small Cap Equity
15% International
35% Bonds
5% Cash

Readers of this blog and many other investors know it is easy to get low cost index Funds to mirror this and similar allocations.

So how is this model doing? Year - to - date thru 9/30 it has  total return of 5.89% and over the 12 months ended 9/30/2016  it has a total return of 10.69%. So the market is hardly going sideways and those who have stayed on the sidelines are falling behind.

I'm just the messenger so don't kill me. And I, along with everyone else, have no idea where the market is going next. I'm just reporting where we are.

Let's consider the results thus far for retirees. For retirees 4% is an important metric. It is the amount that can be withdrawn with an inflation adjustment and have concerns about running out of money be pretty much a non event.

Inflation over the past 12 months on the basis of the Personal Consumption Expenditures (PCE) price Index (the FOMC's preferred inflation measure) is running at 1.7% (ex Food & Energy) through the end of August.

Thus, the retiree who can achieve a return of 4% + 1.7% = 5.7% is right on target. Actually he or she is ahead a bit because they hit the target and they are one year closer to the grim reaper! I hate to put it like that but it is what it is!

In essence the bottom line is that they can end the year with the the same portfolio value in real terms after extracting their income need.

Just one final point on the question " do I have enough to retire?".  As we have seen there has been a sharp rise in the stock market and bond prices from the depths reached in March 2009.

Understandably some people will look at their portfolios, consider Social Security and possibly throw in a pension or rental income, add it all up and conclude they have enough to retire. If you are in this boat I suggest you look at your "nest egg" and only count 80%. In other words take your income from this source at 4% times 80% of your egg. It just means you can withstand a decent size downturn and not be in a quandary. In 2000 and then again in early 2009 market downturns pushed some retirees out of retirement. One of the tricks in retirement is to make it past the first 5 or so years!