In the financial advisory business, one of the most pressing and controversial topics is how much money people need to save during their working years in order to provide for long-term retirement income. The research on this topic has evolved quite a lot in recent years, and a recent issue of Money magazine features a series of articles representing the current view on this critical topic. These articles, based around interviews with a number of the current thought leaders on this topic, deserve to be widely read and discussed.
The series of articles in Money kicks off with perspectives by Wade Pfau. Pfau’s introductory piece suggests a difficult future for American workers. A traditional rule-of-thumb in retirement planning is called the 4% rule. This rule states that a retiree can plan to draw annual income equal to 4% of the value of her portfolio in the first year of retirement and increase this amount each year to keep up with inflation. Someone who retires with a $1 Million portfolio could draw $40,000 in income in the first year of retirement and then increase that by 2.5%-3% per year, and have a high level of confidence that the portfolio will last thirty years. It is assumed that the portfolio is invested in 60%-70% stocks and 30%-40% bonds. The 4% rule was originally derived based on the long-term historical returns and risks for stocks and bonds. The problem that Pfau has noted, however, is that both stocks and bonds are fairly expensive today relative to their values over the period of time used to calculate the 4% rule. For bonds, this means that yields are well below their historical averages and historical yields are a good predictor of the future return from bonds. The expected return from stocks is partly determined by the average price-to-earnings (P/E) ratio, and the P/E for stocks is currently well-above the long-term historical average. High P/E tends to predict lower future returns for stocks, and vice versa. For a detailed discussion of these relationships, see this paper. In light of current prices of stocks and bonds, Pfau concludes that the 4% rule is far too optimistic and proposes that investors plan for something closer to a 3% draw rate from their portfolios in retirement. I also explored this topic in an article last year.
Income inequality is increasingly acknowledged as a key economic issue for the world. The topic is a major theme at Davos this year. Economic inequality is also an increasingly common topic in U.S. politics.
A new study has found that economic mobility does not appear to have changed appreciably over the past thirty years, even as the wealth gap has grown enormously. The authors analyzed the probability that a child born into the poorest 20% of households would move into the top 20% of households as an adult. The numbers have not changed in three decades.
On the other hand, there is clearly a substantial accumulation of wealth at the top of the socioeconomic scale. The richest 1% of Americans now own 25% of all of the wealth in the U.S. The share of national income accruing to the richest 1% has doubled since 1980. In contrast, median household income has shown no gains, adjusted for inflation, since the late 1980’s and has dropped substantially from its previous peak in the late 1990’s.
People have an understandable interest in patterns in stock market returns. As we head into September, we can expect the inevitable articles about the so-called ‘September swoon.’ If you look at the period since 1926, the average return in September has been negative. A 2011 paper in the Journal of Applied Finance concluded that the historical occurrence of negative returns for the stock market in September is so strong and consistent that it cannot easily be explained away. There are a range of other so-called ‘calendar effects’ in which a specific time of the year, month, or week has historically delivered returns that are markedly different from the average across all periods. There are no conclusive explanations for these effects and, in a rational world, these types of anomalies should not persist—but they do. If they expect stock prices to decline in September, savvy speculators should start to sell in August in anticipation of this drop and this selling should dilute the eventual drop in September. Over time, this type of effect should, in theory, disappear to investor anticipatory buying or selling. Nonetheless, these effects remain prominent in historical stock prices. Continue reading →
One of the most interesting market stories in the last week is the big drop in the Japanese stock market. Japan is the third-largest economy in the world, ranked by GDP. The values of the Japanese stock market, as measured by the Nikkei 225 index, dropped by 7.3% on May 23rd, and then suffered another fairly dramatic one-day decline of 3.2% on May 27th.
Over the last five sessions, the iShares MSCI Index ETF, EWJ, has dropped by almost 10% (see chart below). Continue reading →
As the market rally persists, many investors will no doubt be kicking themselves and wishing that they had bought in earlier. Some will convince themselves that they better get on board or risk missing out on this bull market. There are many good reasons to invest money, but choosing to get in because of the potential gains that you could have made is not one of them. In the same way that people capitulate and sell out near market bottoms, there is also a big behavioral driver that seems to make people capitulate and join the herd towards the end of big bull markets. I am not saying that we are poised for decline (I am not a good market timer), but simply noting that buy or sell decisions made on the basis of what you wished you had done last month or last year is often truly dangerous. Continue reading →
Guest post by Contributing Editor, Robert P. Seawright, Chief Investment and Information Officer for Madison Avenue Securities.
Value has persistently outperformed over the long-term. Why is that?
In the most general terms, growth stocks are those with growing positive attributes – like price, sales, earnings, profits, and return on equity. Value stocks, on the other hand, are stocks that are underpriced when compared to some measure of their relative value – like price to earnings, price to book, and dividend yield. Thus growth stocks trade at higher prices relative to various fundamental measures of their value because (at least in theory) the market is pricing in the potential for future earnings growth. Over relatively long periods of time, each of these investing classes can and do outperform the other. For example, growth investing dominated the 1990s while value investing has outperformed since. But value wins over the long haul. Continue reading →
The price of a share of Apple (AAPL) is almost 30% below the high that it set back in September 2012—about five months ago. Even before its peak, the price of Apple shares had already made it the most valuable company in history. In those heady times, Apple shares reached $702. Today, they are at $503. Even today, however, Apple remains the largest single holding in the S&P 500 at about 3.6% of the total index. It is mind boggling to consider that the market value of the most valuable public firm in history could decline by 30% in five months, without some sort of catastrophic event. But this is the situation and there are some lessons to be drawn. Continue reading →
In the first four parts of this article, I have discussed a number of well-known behavioral biases that cause investors to make decisions that are, to put it kindly, less than optimal. In this final installment, I summarize how best to avoid these costly traps.
As these blog posts have been published over the past couple of weeks, the issues are much in evidence. Apple (AAPL), long the darling of the market, has lost favor and Groupon (GRPN) seems to be following a relentless downward spiral. Surely many investors in Groupon must be asking themselves how they could possibly have seen the company as a good bet. Apple stock, which was trading at $700 in mid-September, is currently at $544, a decline of 22% in two months. The news that has come out on Apple does not seem sufficient to justify such a broad shift in the market’s consensus as to the long-term value of Apple as a company. And, of course, we have the poster child of behavioral bias: Facebook (FB). How is it possible that the market’s consensus view of the share value of such a widely held company could be almost 50% below its first day closing price of $38? As Warren Buffett is quoted as saying, in the short-term the market is a voting machine and in the long-term the market is a weighing machine. When voting overwhelms weighing, investor psychology is dominating.
In earlier installments of this article, I have discussed some behavioral biases that tend to influence people to make bad investing decisions. In this post, I explore several more of these biases. The focus of this piece is on how we perceive ourselves and our ability to make independent decisions. One of the key ideas within rational markets is that people gather public information and make informed decisions. Without rational market participants, it is unlikely that markets themselves will converge to appropriate prices for traded assets (stocks, bonds, real estate, etc.). Continue reading →