I had a recent discussion with a marketing representative from a well-known investment management firm. We were discussing allocation of money to "risky" assets versus "risk free" assets. Risky asset refers to stocks or anything that does not have a creditworthy guarantee. A “Risk Free” asset refers to an asset which in theory carries no risk of default and guarantees the return of principal and interest. However, there is not a practical “risk free” asset and all investments contain risk and may lose value. For our conversation we were kicking around zero coupon bonds as a surrogate. He advocated putting the majority of investor money right now in risky assets. I agreed that there is merit to stocks right now, but with reservations. I explained that there is a context to each client portfolio. That context is life.
Prudent Man Rule
The Prudent Man Rule from an 1830 court
case involved Harvard College. It states advisors to money were to “observe how men of prudence, discretion
and intelligence manage their own affairs, not in regard to speculation,
but in regard to the permanent disposition of their funds, considering the
probable income, as well as the probable safety of the capital to be invested."
Further, they are to consider:
The needs of
beneficiaries;
The need to preserve
the estate;
The amount and
regularity of income.
Those of you who know me know that I try
to operate more like this than like our federal government that willfully squanders
money on hot tips like Solyndra, and dubious billion-dollar projects. They
spend money they did not earn. Easy
come, easy go for them. You, however, earned yours. Care and prudence means being
careful rather than doing something
just to be busy with the money in the absence of clear direction. Managing it as I would my own has meaning.
This isn't Congress. We have risk.
Last week’s data on how little the Dow
Jones Industrial Average really made after inflation over the last 6 years (The
Sidewinder) perfectly leads us to what is important about prudence and planning
to retire and staying there once you are there. Our last six years can
be likened to our version of the stock market between 1929 and 1935 in most
ways. If you want to know what could have and still can happen ask your parents
or grandparents what it was like growing up in the 1930s. The take-away is that
an investor with a risk-on, pile it all in stocks strategy was barely rewarded.
Certainly it was not enough to compensate for the risk he took. Life has no
guarantees. The low risk investor likely made more than the high risk investor,
but the numbers were not massively impressive. We were and are a sick, but
improving economy.
The Epiphany
Investment decisions are made in
the context of the real, actual, true, factual, correct, accurate, right,
exact, spot-on, genuine goals.
Life sets parameters. For someone retiring in the next ten years, or
who is already retired, risk presents a problem. If that investor’s personal economy spiraling
out of control puts them back at the office when they should be retired, they
are boxed in, exactly unlike what they envisioned. Angst, worry, antihypertensive therapy, and
another stupid boss are not part of the retirement plan. Let's look at context
categorized.
How well you retire is based on
five ingredients:
- How long you worked
- How much you saved
- How well you invested
- How much you will spend each month
- How long you are retired
I will look at the first one
today and keep it coming over the next few weeks.
How long you worked: Social
Security began in 1935. Life expectancy
was 66 1/2 years. Typical retirees worked
45 years and retired 1 1/2 years. The
work to retire ratio was 30 years to one year or 30:1. Assuming you work 45 years now, your life
expectancy is about 85 years, so you will spend about 20 years in
retirement. The work to retire ratio is
1.8:1. YES, that’s less than 2:1! Social
Security has made changes to accommodate this. Normal retirement age has increased. Special payout programs have decreased. Even the way that CPI calculates inflation has been used to lower payments. A recent study by John Williams of ShadowStats shows that if inflation was still counted the way it was before 1980, the CPI should be about seven percentage points higher each year than it is now. The average Social Security check would be about double what it is today. So, on average, you are working a lesser portion of your life, and you graduate from work with about half the Social Security buying power. You can work longer to increase your benefit. You can also alter the other four ingredients to help.
Chris
