Investment Strategies for a Sustainable Retirement after the Financial Crisis
From the monthly archives:
We have identified three scenarios for the post finanical crisis period: Recovery, Mediocrity, and Instability.
In the video below, denial about the current financial crisis is illustrated and the dangers down the road are described by Peter Schiff, who predicted the financial crisis.
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We all have beliefs about the future. Many are based on hope. Hope-based strategies for investing for a comfortable retirement might not be wise. We call that strategy buy and hope.
If you believe that we will return to a stable financial system where the stock market delivers steady, sustained growth, the Buy and Hold investment strategy is for you. If you have some doubts, read on.
Keith Fitz-Gerald at Money Morning describes how Buy and Hold failed during the financial crisis of 2008.
It was supposed be a simple proposition. Consistently put money to work in the markets, let it ride – and laugh all the way to the bank. The thinking was that you couldn’t go wrong because the markets would go up 10% to 12% a year – each and every year (It’s actually more like 4% to 6% – on average – but that’s another story for another time.
What’s important to understand is that “Buy and Hope” is the greatest myth foisted upon the American public in the last 200 years – the need for American International Group Inc.’s (AIG) retention bonuses, notwithstanding. As millions of investors have found out the hard way, the markets can – and do – frequently go through tremendous periods of readjustment.
This means that timing, as they say, really is everything. And “they” – the brokerage firms, hedge funds, ratings agencies and others that together make up “Wall Street” – don’t want you to know that. Wall Street wants you all the way into the game all the time. It doesn’t care whether you win or lose, just as long as you keep playing. So the collective “they” work together to pitch you whatever’s hot, and then move on when that investment has run its course.
And don’t even get me started about the conflicts of interest. The supposedly independent ratings agencies that rubber stamped everything from derivatives to high-grade debt have been in bed with the companies they’re supposed to be regulating for years. Consequently, millions of investors thought they had the “green light” to invest in supposedly safe institutions that have proven to be anything but during the past 24 months.
Where the rubber meets the road – especially during the down years like we’re living through now – is that the risks of outliving your money go up dramatically if you have to get out. In fact, if you achieve annualized returns of zero or less for the first five years after you retire, your odds of running out of money in the next 30 years more than double from 26% to 57%, a study from T. Rowe Price Group Inc. (TROW) reported recently.
And that’s proving to be a tough reality for millions of investors who thought they had this handled. Which is why I was not surprised to see data from the Employee Benefit Research Institute quoted in Money Magazine showing that more than 30% of near-retirees, or those in the early years of their retirement, had more than 80% of their money invested in stocks at the onset of this crisis.
Many of those investors have undoubtedly sold off assets to finance living expenses while waiting for the market to reverse. And that’s created a “double whammy” of sorts: Not only did they lose money on the way down; but those losses and the subsequent forced sales could well mean that their portfolios won’t be big enough to benefit from the next upturn when it does arrive.
Losses from Buy and Hold in a bear market reduce your potential to take advantage of an upturn. That is why every investor needs an warning system when stuff hits the fan. Investors that I know who moved to cash in the summer of 2008 are feeling very grateful now.
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Scott Adams at Dilbert.com:
Almost everything I ever learned about investing turns out to be wrong. I learned that buying and holding a diversified portfolio of stocks was a sure winning strategy in the long run. So far, my lifetime stock investments are negative. I learned that the safest investment is real estate, especially in California, because “they aren’t making any more land.” That theory hasn’t worked out too well.I learned that investing in California municipal bonds was extra safe because they were insured. That’s great until the insurance companies themselves become insolvent.So if everything that was good is now bad, is there any investment that we all assumed to be bad that is now good? (Other than stuffing cash under the mattress. Too obvious.)
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Gary North uses the economy of recreation vehicle capital of America, Elkhart, Indiana, to describe how the illusions of easy money and overspending have ambused many Americans.
Link: Retirement Living in Elkhart, Indiana by Gary North
Over the last 18 months, Americans over age 55 have suffered a reversal in their capital that has not fully registered psychologically. They will not be able to afford a comfortable retirement.
This was true 18 months ago, just less obvious. Very few Americans enjoy a combination of private pensions, annuities, and Social Security payments sufficient to fund what Social Security says retirees need: at least 70% of their pre-retirement income in the last year of employment. They are oblivious to this assessment on the Social Security website.
Today, about half of all workers are covered under an employer-sponsored pension, and many people are not saving as much as they should. While Social Security replaces about 40 percent of the average worker’s pre-retirement earnings, most financial advisors say that you will need 70 percent or more of pre-retirement earnings to live comfortably. Even with a pension, you will still need to save. If you will not have a private pension, you will need to save more – and start saving sooner.Yet throughout Greenspan’s bubble economy, the savings rate of American households fell, going negative in 2005. The boom fooled Americans who owned stocks that they were getting richer. They weren’t. They were merely benefitting from the greater fool theory of investing. That theory has brought down the real estate bubble. There will be further declines. It has ended the stock market mania. And it has just about shut down Elkhart, Indiana.
Americans have not yet recognized what has been done to them by the Federal Reserve System and the highly leveraged banks and hedge funds that thought the good ship Effortless Wealth had come into port. The hot-shots did not understand Ludwig von Mises’ theory of the business cycle as the product of central bank monetary inflation. They never saw it coming.
Now the investors who believe the same dream, but without multimillion dollar severance deals, have seen their dreams called into question.
They have not yet dumped their stocks. They have just stopped buying as many. The fall of 55% by the Dow and the S&P 500 was not accompanied by a huge sell-off. The decline has been one of dribbling away. The dreams of would-be retirees have not yet been smashed. They have merely dribbled away. The crash has not yet come. It will.
STAGES OF DECEPTION
First, there is a dream: easy prosperity. This dream is funded by fiat money. Next, there is a boom: easy prosperity. This boom is funded by fiat money. Next, there is reality: the stabilization of fiat money. Next, there is recession: the end of the dream. [click to continue…]
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Charles Hugh Smith at the Of Two Minds blog delivers an unpleasant message in End of an Era: What Isn’t Coming Back. He says the financial crisis is the just beginning of some tough times caused by overspending instead of saving, at all levels. We can ignore his message, evaluate the message, or believe the message. Charles makes some important points here, so I don’t recommend that we ignore the message or kill the messager. Instead, let’s see if we can learn anything that is worthwhile.
Below he identifies six conditions which underpinned the bogus prosperity of the past decade have changed for good.
1. Permanent decline of the assets which supported rampant consumerism. Having gleefully swallowed the fiction that real estate could rise indefinitely, and thus fund not only a plump retirement but a never-ending consumer binge, the American middle-class is now coming to grips with the reality that real estate valuations were a bubble which has burst. The bust is taking down the primary asset of the Baby Boom generation (housing) and the equity-extraction-machine of home equity lines of credit (HELOC).
… the entire superficial surface of jewelry, lavish cruises, huge suburban homes, etc. was based not on a foundation of savings and productive real wealth but on astonishing increases in debt. It was never sustainable, and the fantasy that it was sustainable, and perhaps even “deserved,” was always visibly absurd.
But it’s not just housing which has plummeted; it’s all assets classes. And that decline hasn’t just shattered consumer borrowing, it’s also wiped out much of the retirement wealth of the Baby Boomers. (Physical gold has risen in value, but other commodities have seen boom-bust cycles of appalling volatility.)
2. With their assets diminished, Boomers must now save rather than spend. The decimation of Boomer assets and retirement funding is documented in this report sent to me by longtime correspondent J.F.B., who has been presciently pointing out the risks to the Boomer retirement for some time: [click to continue…]
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JT Grenough recommends a macroeconomic view of adapting to the financial crisis.
You have to consider macroeconomics before you reposition your assets. You have to reposition
assets. You have to close all major risks. Exit the majority of money funds and currency time
deposits, step up gold and oil positions, and move into non-US government bonds in First World
nations. Switzerland is a prime consideration, but there are first-class world banks with branches
just a short flight from Florida. You have to modify your thinking as if you are on a special ops
tour of duty. Otherwise the current toxic economic environment will continue to deplete non-
repositioned assets.JT Grenough (New World Order Economics – What You Can Do To Protect Yourself , published Jan 2009)
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David Rosnick and Dean Baker at the Center for Economic and Policy Research released a report in February 2009 that provides a sobering picture of the retirement prospects for many baby boomers. Key excerpts are included below.
Link: The Wealth of the Baby Boom Cohorts After the Collapse of the Housing Bubble
Workers have a limited number of years during their lifetime in which they can accumulate wealth toward retirement. If they save little or nothing during a substantial portion of these years because they expect wealth generated by a bubble to persist and grow further, then they are likely to find themselves ill-prepared for retirement when the bubble bursts.
… as a result of the collapse of the housing bubble, the vast majority of baby boomers will be approaching retirement with little wealth outside of Social Security. While the younger baby boomers will still have some opportunities to accumulate wealth in the years until they retire, it is unlikely that the picture will be very different after a relatively small number of additional work years. This means that cutting back Social Security and Medicare from current levels will impose serious hardships on this age group.
Finally, these projections should make clear that home ownership is not always an effective way to accumulate wealth. Home ownership during a housing bubble was a route toward losing wealth, not accumulating it. While typical homeowners cannot be blamed for not recognizing the bubble, the economists and policy professionals who designed policies that pushed homeownership certainly can and should be blamed.
It was possible to recognize a bubble at least as far back as 2002 based on the sharp divergence in
house prices from their historic trend. The fact that so many economists and policy professionals
failed to recognize and warn of this bubble had enormous consequences. Unfortunately, the people
who listened to these experts are likely to suffer the consequences of the experts’ failure, rather than
the experts themselve
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