Archive for October, 2009

GDP Turns Positive (Sort of)

Kurt Brouwer October 29th, 2009

U.S. GDP rises 3.5% as stimulus kicks in (MarketWatch, October 29, 2020, Rex Nutting)

The U.S. economy expanded at a 3.5% annual pace in the third quarter, as massive government stimulus helped drag the economy out of the longest and deepest recession since the 1930s, the Commerce Department estimated Thursday.

This is an estimate and will almost certainly get revised.

Along with improvements in key monthly figures on output and sales, the rise in real gross domestic product means the Great Recession is likely over in a technical sense, even as further job losses occur. A formal call on the end of the recession isn’t expected for months

…It was the first increase in real gross domestic product in a year and it was the strongest growth in two years, the government said. Before growing in the June-to-September quarter, the U.S. economy had shrunk for four straight quarters for the first time since the Great Depression.

…In the past year, the economy has contracted 2.3%. The economy shrank 0.7% annualized in the second quarter and 6.4% in the first quarter. The figures are seasonally adjusted and adjusted for price changes.

…Third-quarter growth was due to higher consumer spending, a slowdown in the reduction of inventories, an increase in residential investments, and robust government spending…

How much of the growth was due to stimulus and other forms of robust government spending? The Bureau of Economic Analysis report referenced above can be found here.  It gives us a bit more detail on the elements of GDP growth:

…Motor vehicle output added 1.66 percentage points to the third-quarter change in real GDP after adding 0.19 percentage point to the second-quarter change…

Yikes.  That is, of the 3.5% growth, fully 1.66% came from motor vehicle output and that, of course, was goosed mightily by Cash for Clunkers.  If vehicle output had come in at the same level as the second quarter, then GDP growth would have been only been 2.03% (3.5 - 1.66 + .19 = 2.03).

This chart illustrates what I meant by vehicle sales were goosed by Cash for Clunkers:

Source: Clusterstock

The little sign in the chart indicating a car going off a cliff presumably is suggestive of a likely decline in vehicle sales now that Cash for Clunkers is over.  I would be shocked if we did not see a big dropoff in vehicle sales.

So, the good news is that the economy has sped up and we are seeing modest economic growth.  The bad news is that growth is still heavily dependent on various government spending programs which are unsustainable.

Senate Committee Pans Target-Date Mutual Funds

Kurt Brouwer October 28th, 2009

Many 401(k) plans use target-date (or lifecycle) mutual funds.  A target-date fund is structured to embody a diversified portfolio for a person who plans to retire in a given year, say 2030. The longer the fund is from its ‘target date’ the more its asset mix will favor higher risk investments such as stocks.  As a fund gets closer to its target date, the asset mix would supposedly be changed to reflect more conservative income investments. So, theoretically, a target-date 2030 fund would almost certainly have a much higher commitment to stocks than a target-date 2015 fund would.

This Bloomberg piece notes a Senate Committee report that paints an unflattering picture of this burgeoning group of funds:

Kohl Says Target-Date Funds May Present Conflicts of Interest (Bloomberg, October 28, 2020, Jeff Plungis and Margaret Collins)

Target-date mutual funds suffer from high fees, limited choices and potential conflicts of interest, a Senate committee was told today.

Ouch.  I suspect this report is causing a few migraines in the marketing departments at the large mutual fund companies.

Employers who offer workers the funds as part of their 401(k)s retirement plans typically can’t choose the investment mix, according to a staff report delivered to the Senate Special Committee on Aging at a Washington hearing. Companies often are limited to the administrator’s own mutual-fund offerings, the report said.

…Target-date funds, also known as lifecycle funds, move money from riskier investments such as stocks to more conservative alternatives like bonds as an investor approaches retirement. Contributions have grown 98 percent since they were endorsed as a default option for employers by the 2006 Pension Protection Act, according to Morningstar Inc.

…Target-date funds labeled 2000 to 2010 lost an average 23 percent last year with some dropping as much as 41 percent, according to data compiled by Morningstar, the Chicago-based mutual-fund research company. The average 2050 fund declined 39 percent in 2008, while the Standard & Poor’s 500 Index fell 38 percent.

…More than $140 billion has flowed into target-date funds since 2007, and 96 percent of employers that offer automatic enrollment use them, the Senate report said…

Target-date funds certainly could be useful, but they may not make sense as a default option for 401(k) participants.  A default investment option is the one that a retirement plan must put your contributions in if you have not actually made a selection from the plan’s menu of investment choices yourself.

Will you run out of money in retirement?

Kurt Brouwer October 28th, 2009

‘Life should  NOT  be a journey to the grave with the intention
of  arriving safely in an attractive and well preserved  body,
but rather  to skid in sideways - Chardonnay in one  hand -

chocolate in  the other - body thoroughly used up,  totally worn out and
screaming ‘WOO  HOO, What a  Ride’ 


I’m not sure who actually wrote this, but it does contain a very different perspective on planning for retirement, doesn’t it?  My only quibble has to do with the wine selection.  I always thought chocolate went best with a nice, full-bodied red.

Most of us do not have the perspective of the author of this pithy paragraph though.  In fact, one of the key concerns — perhaps the key concern — people have about retirement is whether or not they will run out of money.

In answer to that question, the answer is almost certainly no.  That is, you won’t run out of money.

Here’s why. Think of your gas tank in your car.  If you were on a long trip and the circumstances were that you were getting low on gas and no gas stations were available, what would you do?  Would you keep driving at high speed knowing that would burn gas quickly or would you cut back to the most efficient speed in order to conserve?  Answer: you’d conserve.

The same is true of conserving your assets in retirement.  If things looked tight, you would cut expenses and reconsider assumptions you had made long before a shortage would come about.  You would make changes, consider new options and, in a variety of ways, you would think outside the box.

Retiring outside the box

As an example of thinking or even retiring outside the box, I was chatting with a client who complained that his retirement expenses were unsustainable given his steady income and savings.

I was kidding a bit, but I said, “You could always move to Guatemala.”

The thinking behind that statement is that many American and Canadian retirees have moved south of the border to expatriate enclaves in Mexico, Guatemala, Costa Rica, Panama and Nicaragua.  Living expenses are generally much, much lower in those places.  The client laughed and told me he had given some thought to living half the year in Mexico.

In other words, though you may think you’re going to retire and maintain all your present circumstances, that may not be the case either because you want a change or because you need to change.

You can have (almost) any thing you want, but not everything you want

In other words, there are definite tradeoffs in planning for retirement.  If your primary goal is just to have the money for a simple, comfortable retirement, then that’s probably fine.  But, if you begin adding on requirements, you may impinge on your primary goal.

Let’s say you are about to retire and you want to figure out how much you can spend each year during retirement.  Before getting into formulas or related concepts such as inflation, in my view, the key question is this:

What do you want?

When I ask that question, people generally have a pretty clearcut plan on certain issues such as:

  • I want to leave $_____ to my kids or my church or my charity while providing for a comfortable retirement
  • I’m mainly concerned about retirement income and if there is anything left over, it will go to our kids
  • I am worried that our retirement needs could become a burden to our children
  • I don’t want to leave any money to anyone; so I want to write my last check on my deathbed

The details may vary, but your retirement goal should be clearly stated.  For most people, the primary concern is providing for their own retirement expenses.  Beyond that, they either want to pass on some of their wealth or they don’t.

Once that issue is addressed, the next issue is how much can you spend on yourself — on your lifestyle — during retirement?  The viability of a retirement spending plan rests on three primary components — your spending, your steady income and your savings.

All three of these have to be considered together in order to come up with a coherent answer to the question, will you run out of money in retirement?  Obviously, we cannot know the future, so we are speaking in terms of probabilities, but it is useful to go through this type of analysis:

I. Spending during retirement: Let’s say you are on the cusp of retiring.  First, congratulations are in order.  You made it.  Next, let’s take a look at how you figure out what you’ll spend during retirement.  The best place to start is to figure out how much you spend now.  I know that sounds obvious, but many people don’t really know what they are spending.

We use a Microsoft Excel worksheet to help people go through this exercise so they don’t miss any major spending categories.  One of the biggest spending black holes is your home.  People spend a lot of money on upkeep and maintenance, insurance, property taxes, principal and interest payments and home improvements.  It’s easy to miss something.

Your home: Are you planning to stay where you are?  If so, home expenses may not change much, until you pay off your mortgage.  If you plan to downsize your home, will you buy a condo or rent.  For many retirees, renting is hard to imagine as they have owned a home for decades, but renting makes economic sense for many.

Your state or city?  If you are planning to move, are you considering another state.  If so, the cost of living in that state is important as are all the various taxes (income tax, sales tax, property tax).  There are places around the country — and around the world — where your money may go a lot further than it does where you live now.  Or, you may be considering a move to be close to family or even to bring about a lifestyle change.  A change such as this complicates things, but that’s OK.

Other easy items to miss are expenses that come once a year (such as many types of insurance) or expenses that occur irregularly, such as replacing a car or a furnace or a roof. Once you have a good handle on how much your spend now, you can estimate what you will spend in retirement.  In order to look forward in terms of spending, you have to make some decisions:

There are rules of thumb for adjusting your working level of income to see how much you will need in retirement, but I have not found them terribly useful.  I think it’s much better to track your current spending and then go through and make adjustments to deal with your contemplated lifestyle changes during retirement.

One of the best ways to estimate retirement expenses is to talk with those who are already retired.  This is not a huge revelation, but I have found that many folks are reluctant to ask family members or friends or others about what life in retirement is like or to find out how their spending compares to spending before they retired.  Most retired folks that I know are happy to help others and share their knowledge.  So, if you have questions, just ask.

II. Steady Income: Figuring this out is generally the most straightforward part of the process.

Social Security: Most people will have Social Security income during retirement and the Social Security administration sends out a specific statement for your personal Social Security benefit at retirement.  The only big decision for Social Security is whether or not to take it immediately or to wait until full retirement age.  This chart from the Social Security administration illustrates how your initial monthly benefit can change depending on your age when you start taking Social Security.

Source: Social Security Administration

As you can see, assuming a retiree has a full benefit of $1,000 per month at age 66, the actual benefit could be higher or lower depending on what age the retiree actually elects to start taking the benefit.  Many articles I have seen recommend waiting until age 66 to get the full benefit.   That may not necessarily be the best choice for many people because you have to give up four years of Social Security benefits to get the higher amount.  The reason it may not make sense for you to wait until full retirement age is that the crossover point could be about 12 years.  That is, it takes 12 years at the higher benefit amount to make up the amount you missed by not taking benefits at 62.

For example, using the numbers in the chart above, at age 62, you would get $750 per month for four years for a total of $36,000.  On the other hand, if you wait until age 66 for full benefits, you would get an extra $3,000 per year ($250 per month).  Without getting too fancy, in actual dollars it would take 12 years to make up the money you missed by waiting.

If you plan to work until 66, it probably makes sense to wait to take benefits until that age.  However, many people may want to take benefits at 62 just to bring in some income.  That method will give you more money until the crossover point is reached in about 12 years.

Many folks will have some part-time or full-time employment income during the early years of retirement and that could impact your decision on when to take Social Security benefits among other things.  For more on this issue, you can go to the Social SecurityAdministration’s Retirement Benefit site.

Other pension benefits:  If you are lucky enough to have an outside pension plan from your employer, then that is an additional source of income during retirement.  In addition to the pension income, you may also be eligible for additional benefits such as retiree health insurance.  One very important question to consider with an outside pension is whether to take the monthly income option or to take a lump sum distribution, assuming that option is available to you.  If you are at all concerned about the level of funding for your pension, taking a lump sum may make sense.

III.  What assets do you have?

This refers to your investments, whether IRAs, 401(k)s or personal savings or investments.  We typically include retirement assets if you have them in an account in your name.  We include monthly pension income above under Steady Income.  Looking at your assets means you would also potentially include other assets such as your home or a business or anything else you have that is valuable.  You may want to remain in your home now, but it is still a resource if you have some equity in it.

If there is a gap between your spending (Section I) and your steady outside income (Section II), then your portfolio has to be tapped to make up the difference, if you cannot cut expenses that is.

People often ask what is a reasonable return for retirement assets and that is hard to forecast because returns vary dramatically from year to year and from one type of asset to another.  If you have your investments in a diversified portfolio, then you could consider historical rates of return, that is the long-term average return for each type of investment.  We look at those historical returns and then make adjustments according to our view of conditions in the future.

What kind of spending assumption should I make?

What we often do is look at a 4-5% withdrawal rate from your portfolio.  That is, if someone has a long-term portfolio, then he or she should be able to withdraw 4% per year from that portfolio without drawing it down to zero over the course of a normal retirement.  The way the math works on this is to assume a return from a diversified portfolio of say 8%.  Then, from that 8% return, deduct your inflation assumption.  Say, that’s 3% and the remainder, 5%.  Assume some income taxes, albeit at a fairly low rate, and 4% is left that can be spent without dipping into your principal on an inflation-adjusted basis.  In this scenario, you would be able to pull out 4% per year and also to keep your principal intact even with the ravages of 3% inflation.

However, you may not be as concerned with inflation as you get older depending on your initial goal.  For example, if you plan to write your last check when you check out, then keeping your principal intact will not matter much to you.  Or, if your primary concern is your own retirement span and whatever is left over, if anything, could go to your children or a charity, then again keeping up with inflation may not concern you too much.

In these cases, you could spend quite a bit more than 4% because you don’t mind dipping into principal and because you don’t care if the portfolio value does not keep pace with inflation.

Another alternative we have seen is that retired folks take out more than 4% in years when investment returns are good, but they cut way back on withdrawals from the portfolio in down years.  That can work if you are disciplined.

Living longer & margin for error

One point to bear in mind also is longevity.  The good news is that life expectancy is going up and people are living much longer.  Initially, most recipients of Social Security did not last all that far beyond 65.  Now, people are routinely living well into their 80s or 90s.  That is one reason why Social Security funding is a problem.  But, it is also a problem we need to consider as part of a retirement plan.  How long are you planning to live?  Or, what life expectancy would you like to assume.  A reasonably healthy couple, each of whom are at age 65, will likely be around for quite a while, and one member of the couple could easily live 20 years or more.  Therefore, retirement planning needs to account for a potentially long life span.

I believe you also need to have a cushion in your planning to account for the possibility of getting lower investment returns or other factors such as higher inflation or a long, long life.

Summing it all up

When you begin thinking about these issues, the temptation is to go right to one of the retirement calculators you can find online (see here or here or here for examples).  That’s fine.  Do it.

But then, you actually have to sit down and do your own personal math.  Track your expenses.  Make adjustments based on what you hear from retired family or friends.  Add in your steady income from Social Security or other sources.  And, finally, make a conservative assumption of what you can take from your portfolio to make up any difference between spending and steady income.

As you can see, this is a very personal decision as your goals could be quite different from those of family members or friends.  If your situation is complicated or if you want a more rigorous retirement analysis, you would need to go to your CPA or financial advisor for help.

Have fun and if you have an interesting tale let me know.

Surprising Corporate Earnings Buoy Stocks

Kurt Brouwer October 26th, 2009

One element in the stock market’s strong showing this year is simply a reaction to last year’s horrendous downdraft.  Another element that has more substance is improving corporate earnings.

This charts shows results the percentage of companies that are revising earnings upward (or downward).  The chart tracks the S&P 1500, which is a broader index than the S&P 500.  The S&P 1500 covers about 85% of the U.S. stock market.

In this chart, the blue line shows the price movement of the index on the left axis and the red line shows the percentage of companies (right axis) that were either raising or lowering earnings estimates at a given point in time.  Currently, the red line indicates that a number of companies are now revising estimates upward (above zero on the right axis).

Last year and even early this year, most companies were revising earnings estimates downward in line with the slumping economy.  Eventually, that trend began to reverse and the number of companies posting reduced estimates began to diminish.  The improved outlook for earnings coincided with the low point stocks hit back in March.

Source: Bespoke

Corporations are revising their earnings estimates upwards as we can see from the chart.  Yet, they are also beating those upwardly-revised estimates.  This is what needs to happen for a while if stocks are to go on a sustained upward path.  As the folks at Bespoke put it:

…Upside estimates have been outpacing downside estimates for a few months now, and companies have still been able to beat estimates at a high rate, which we believe is a major reason for the rise in the overall market…

This chart, also from Bespoke, shows the percentage of corporations beating their earnings estimate and puts this period in the context of the recent past:

Source: Bespoke 

Bespoke continues:

In conclusion, the data shows that companies have been beating raised estimates and not lowered ones during this bull market…

The key issue here is the long-term trend.  Are corporate earnings just bouncing back from last year or are they embarking on a new, sustained uptrend?  We will keep watching this and let you know.

How do we fix the Federal deficit?

Kurt Brouwer October 21st, 2009

In my post on the $1.4 trillion budget defict ($1.4 Trillion Federal Budget Deficit), I wrote:

…Neither the Republicans nor the Democrats can claim any glory when it comes to spending control.  Politicians seldom get criticized for spending our money, so they keep right on doing it.  We can assign blame to different players and parties, but that still begs the question: ‘What the heck do we do?’

…We cannot run such massive deficits indefinitely on that much there is agreement.  But, where is the plan for how we bring spending and revenues more closely into balance?  If there is one, I have not seen it.

In response, one of my readers asked this in a comment:

So how do we go about fixing the deficit?

Answer #1: Balance the budget. 

One obvious answer would be to argue for balancing Federal spending and revenues.  There is one problem though, which is that we have only had something like 12 years out of the past 78 (since 1930) in which we had a balanced budget or a budget surplus.  So, being a practical sort, I am suggesting that a balanced budget is a pipe dream.

As you can see from the chart below, Federal spending (red line) and receipts (blue line) have been out of balance for long periods.  The pattern seems to be that deficit widens during recessions (gray bars) and narrows during times of economic expansions.  However, the trend for many years — with the exception of the late 1990s — has been to be in deficit. That is, Federal spending has almost always outpaced tax revenues.

Source: St. Louis Federal Reserve

As you can see, Federal spending and revenues seldom balance. Here is the same chart covering the period 1970 - 2008:

Source: St. Louis Federal Reserve

Must we balance the budget?

It would seem that we seldom actually balance the budget and we primarily operate in a deficit.  So, that begs the question: do we need to balance the budget?  In terms of a family or a business, the answer is unquestionably yes because the family or the business would eventually go bankrupt when it ran out of cash to spend.  Some families or businesses could last longer than others, but eventually the reckoning would come.

But, the Federal government is different because it is a permanent entity unlike a family or a business.  And, it can issue debt that is backed by the government’s ability to tax us in order to pay off the debt.  So, to answer the question, does the Federal government need to balance its budget, the answer is not necessarily.  It might be better for monetary reasons to do so, but it’s not absolutely necessary.

If we don’t have to balance the budget, what should we do?

Answer #2:  Keep the deficit in an acceptable, long-term range:

We have not balanced the budget very often, so an exact balance may not be necessary, but we should try to keep deficit spending in a range of $200 billion or less in times of economic expansion and $400 billion or so in times of recession.  Over time, that range would expand a bit to keep pace with inflation.

As you can see from this chart of the deficit/surplus, keeping the deficit in a reasonable range is something we have done quite well, until recently.  In normal times, keeping spending and receipts within shouting distance is doable, with a bit of fiscal restraint from our leadership.  The blue line indicates a deficit when it is below zero and a surplus above zero:

Source: St. Louis Federal Reserve

Tax revenues plummet while spending soared

Recently, the long-term pattern of manageable budget deficits has changed — for the worse.  Spending under the Republican Congress (until the 20006 elections) was largely unrestrained.  Fortunately, beginning in 2003, the economy recovered and tax revenues recovered along with the economy so that the deficits were not bad.  But, then the economy began falling into recession and tax revenues fell off while spending picked up.  Then, with the the financial panic of 2008, economic activity cratered and tax revenues plummeted at the very time that spending went up dramatically.

Now that the recession is winding down, government spending should get cut back and tax revenues should pick up.  Unfortunately, there is no sign that spending is being cut.  In fact, Congress has shown no ability to cut spending or even to stop increasing it.  Hence, the red line is shooting north.  And, individuals are making less money and many millions are unemployed, so individual taxes are down.  However, the big revenue killer is corporate income taxes.  Companies have not made much money in a long time and corporate tax receipts are down about more than 50%.  That hurts.

On its Tax Vox Blog, the Tax Policy Center made this point quite well:

…Corporate income tax revenues took the biggest hit, down by more than half from 2008. The deep recession wreaked havoc on corporate profits, leaving a large majority of firms with no tax liability. The consequent $165 billion drop in corporate taxes accounted for nearly 40 percent of the total revenue decline…

Source: Tax Vox Blog

Big deficits as far as the eye can see

Tax Vox continues:

Total federal revenue in 2009 amounted to just 14.9 percent of GDP, the smallest fraction since 1950 and far below the 26 percent of GDP spent by the federal government. That gap will narrow in coming years but CBO projects that it will average more than 4 percent of GDP over the next decade, and that’s only if the 2001-2006 tax cuts expire in 2011 as scheduled. Extending those cuts, even only for President Obama’s broad middle class, will mean deficits as far as the eye can see.

Fiscal restraint 

Congress controls the Federal government’s spending so Congress is the root of the problem.  Or, maybe you could say that we are the problem because we elect representatives who do not focus on fiscal or spending restraint.  This is not a partisan comment because it applies equally to Republicans, Democrats and Independents.  Our representatives in Congress get their clout through passing legislation which means spending government dollars.

In other words, Congress is the solution as well as the problem.  I believe Congress needs some kind of powerful restraint from its bipartisan spending habit.  Ideally, voters would elect fiscally responsible folks to Congress, but that has not happened or it may be that life in Washington brings out the spendthrift in the best of us.  Absent voters, where will the restraint come from?

Divided government & the Clinton years

As you can see, we have been in deficit for most of the past 38 years.  The only time period where we were in surplus was 1997-2000, the last four years of President Clinton’s presidency.  During that period we had divided government, with President Clinton (a Democrat) on one side and Congress (controlled by Republicans) on the other side.

Looking back on that time period, it occurred to me that divided government may have its merits.

See also:

Can our government borrow unlimited sums?

Government: It ain’t broke yet, but just wait

50 Ways the Feds Waste Our Money

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