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.
Marc Andreessen, a venture capitalist, remains best-known for his work on the creation of Netscape, one of the earliest and best web browsers. In a recent interview with The Wall Street Journal, he states that those who are concerned about a new stock market bubble in tech stocks simply don’t understand the revolution that is underway and how large an economic impact software firms can have. Continue reading →
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 →
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 →
Every year when the forecasts for the hurricane season are issued, there have been a spate of articles on implications for investors. This year was no exception. USA Today reported that U.S. natural gas prices jumped 3% on the basis of a forecast for an active hurricane season in 2013. It is also common to read that companies are attributing poor earnings to unusual weather. Continue reading →
The financial media loves a catch phrase and, with the apparent emotional hook of the ‘fiscal cliff’ diminished, we needed a new one. The current best candidate is the so-called ‘Great Rotation.’ The idea here is that investors, finally and completely fed up with the dismal returns from bonds, are going to move heavily back into equities. This is the ‘Great Rotation.’ When I Google the term, there are 820,000 search results. Not bad for a phrase that was invented in October 2012 (in a research note from Bank of America, apparently). Continue reading →
I have been struggling to understand a problem that I am going to refer to as the ‘yield paradox.’ Yields for individual asset classes look low. The 10-year Treasury bond is yielding about 1.9%, and 30-year Treasury bonds are yielding a similarly paltry 3%. The S&P 500 is yielding 2.1%, which is very low by comparison to historical levels. Investment-grade corporate bond indexes are yielding less than 4% (see LQD, for example, at 3.8%). Given that the official rate of inflation for 2012 was 1.7%, these yields mean that investors are getting very little yield net of inflation. The very low yields on bonds and on stock indexes is a direct result of the Fed’s actions in holding interest rates at historical lows via Quantitative Easing. We have not yet gotten to the paradox. Continue reading →
There is increasing evidence of big flows of money into equities and leaving bonds. This is being seen at all levels in the market, including among institutional investors such as pension plans. The Wall Street Journal just published an article discussing this shift called Are Mom and Pop Heading for Wall Street? Mutual fund flows suggest that investors are finally returning to equities, after selling in droves over the past several years. This article summarizes the issue:
From April 2009 through now, mutual-fund investors sold a quarter trillion dollars in stock funds, according to recent data from the Investment Company Institute.
Ironically, that selloff coincided with a period of stellar performance in stocks—when the Dow Jones Industrial Average jumped more than 60%. Continue reading →