RETIREMENT ACCOUNT

A friend has been making changes to his retirement account allocations. A month ago, his account was poorly structured and it was invested in high expense funds. He was virtually guanteed that his account would underperform any reasonable benchmark. This fellow is in good health. He expects to draw-out the least allowed by law starting in 20 years. His wife is the beneficiary. He or his wife are expected to live 40 years or more. He hopes to will the balance to his children. In summary, althought the duration of this account is 30 years or better, more than 50% of his funds were invested in bonds with an average duration of 4 years.

Old genererals and investors fight the last war. Investors are still shell shocked after the dot.com bubble. Many folks added funds to the market after it was at extreme highs. Now they are more afraid of capital loss than they are of inflation. Inflation is a much more certain risk than is loss of capital.

Which is more likely, that the stock market will be lower ten years from now or that food will costs more!

Surely if asked the above question, most people would agree that the price of food will likely be higher. They may grudgingly admit that they believe stock prices will be higher. Many still hide their money in the cash purchase of rental property, in bank cds or in bonds and bond funds.

What if their investment horizon is 20 years? Will food be higher? Will stocks be higher? Will interest rates be higher? A long-term view point makes capital loss pale in comparison to inflation risk.

I shared the following information with my friend.

Odds of losing money in the average S&P stock:
1 year: 24%
5 years: 6%
10 years: 1%
20 years: 0%

In answer to the above question, the risk of capital loss in 10 years is only 1% but the risk of inflation loss is 100%.

Odds of earning 10% or more annually in the average stock:
1 year: 57%
5 years: 64%
10 years: 70%
20 years: 78%

Odds of averaging 10% with cds or bonds probably less than 1%

Folks hiding in bonds may not appreciate the interest rate risk or the inflation risk. The following table shows the decline in bond values if there is an increase in rates.

If rates rise .5%:
5-year bonds will decline 2.2%
10-year bonds will decline 3.7%
20-year bonds will decline 5.3%
30-year bonds will decline 6.1%

If rates rise 2%:
5-year bonds will decline 8.3%
10-year bonds will decline 13.7%
20-year bonds will decline 18.1%
30-year bonds will decline 21.1%

Investors sometimes ignor inflation because prices go up a little bit at at time. Interest rate risk is currently at historically high levels as interest rates are at historical low rates!

Another way to gauge the inflation risk is to look at ones retirement hopes. If one hopes to retire with a $50,000 annual income, one must adjust for the fact that in 20 years one will need about $100,000 for the same life style as $50,000 will buy now.

Those who currently earn less than $50,000 can count on social security for about half of their retirement needs. Those who earn more than $50,000 must save more than half of their retirement needs. The following table shows the percentage needed and the amounts provided by Social Security.

Income $40,000; % needed in retirement 71%; % provided by Social Security 44%
Income $50,000; % needed in retirement 74%; % provided by Social Security 37%
Income $60,000; % needed in retirement 75%; % provided by Social Security 31%
Income $80,000; % needed in retirement 84%; % provided by Social Security 23%
Income $150,000; % needed in retirement 86%; % provided by Social Security 13%

Bond substitutes: Solid, high yield, large cap stocks make good substitutes for bonds in this environment. There are several necessary points to consider.

1. Bond rates are extremely low.
2. Bonds could easilty decline 10% more in value.
3. The worst year ever for solid, high yield, large cap stocks was down 15%.
4. Dividend yields for many in this group are equal to or better than bond yields.
5. The investment horizon in this account is more than 20 years!
6. These stocks have never had a negative return for any 5 year period!
7. These stocks have beaten cash investments 95% of the time!
8. These stocks have beaten long-term corporate bonds 100% of all 10-year periods!
9. These stocks have beaten long-term bonds 95% of all 5 year periods!
10. In bear markets, institutional investors pile onto these stocks; they tend to go up when the market is going down!

In summary, I am thankful that my friend allowed me to help him restructure the account. He and I compromised on the final allocation. The allocation had to be comfortable for him; after all it is his money. Never-the-less, we decreased his carring cost dramatically and increased his projected return by almost 2%! Two percent compounded over the next 30 or 40 years will make a huge difference

He now owns a more diversified account than before. I feel good. I have helped a friend make a higher rate of return while taking less risk!

BUY THE BIG BULL!
MANY FOLKS BEMOAN THE US SAVINGS RATE.
REALITY IS: SPENDING MAKES AN ECONOMY STRONG.
AMERICANS ARE CURRENTLY ENJOYING RECORD NET WORTH AND RECORD DISPOSABLE INCOME.
AS THE GM AND WAL-MART SALES REPORTS SHOW, AMERICANS ARE SPENDING MONEY.
CORPORATIONS ARE MAKING EXTRAORDINARY PROFITS.
STOCKS ARE CHEAP RELATIVE TO BONDS AND REAL ESTATE!
BUY THE BULL!