Retirements on Hold 14 comments
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Everyone knows the story of the little boy who found that he was able to get into the cookie jar while Mom and Dad were busy doing chores around the house. First he took one cookie and rearranged the remaining morsels around so nobody would notice. Soon enough, however, he had to have another and repeated the process. We all know how this story ends. Eventually, the little guy had eaten so many of the cookies that it is no longer possible to hide the fact that there were but a few left. No amount of shuffling or jumbling could hide it any longer. Sadly, this is rather analogous to the state of retirement savings for many Americans today.
Let’s take a step back for just a bit and think about the last 9 months or so. Back in October 2007, the headlines screamed of new record highs in the DOW and S&P and forecasters were saying that 2008 would be the year the NASDAQ would start the ascent back to its pre-2000 prominence. Ironically, we were already 2 months past the mainstream acceptance of the credit crisis, and while that should have taken precedence, it did not as Wall Street and the media preferred to focus on the soothing tonic of Fed rate cuts.
During this same period, Austrian economists and commentators were focusing on the deteriorating fiscal condition of America and, in particular, what to do about Social Security and Medicare as the baby-boomers edged closer and closer to taking the pyrite watch and assuming retirement status. We pointed to the fact that debt levels were sky high, the housing market was getting worse, despite calls of ‘bottom’ from every direction, and inflation was becoming a serious problem.
Many mainstream financial commentators have delved into the problems facing retirees over the past year. While these commentators have correctly identified many of the challenges facing retirees such as health insurance, living on a fixed income, and a decreased ability to tap equity from their homes, they have missed an important aspect of this situation.
Easy to lose, difficult to recover
While many recent headlines have highlighted the problems of Fannie Mae (FNM) and Freddie Mac (FRE), precious little attention has been paid to the dire straits that current and rising retirees now find themselves in. While the financial firms now have the explicit backing of the Federal government, the retiree has no such luxury. How much damage has been gone to the retirement funds of these individuals since October 2007’s record highs? For example, the Dow Jones Wilshire 5000, which is the broadest measure of total market capitalization here in the United States has lost over $3 trillion in shareholder value since the highs of 9 months ago. This represents a 20% haircut. Granted, much of that money was lost by brokerage houses and large institutions, but make no mistake about it, boomers anxiously awaiting retirement saw their portfolio values plunge too; at precisely the wrong time.
The truth of the matter is that it generally takes years to recover a 20% loss. Let’s say for example that someone had $100,000 in a retirement account and lost 20% of that since last October. Let’s assume that starting today, market conditions return to normal and the individual can expect to earn 8%/year in the stock market; a charitable theory given the times we’re in. The following would represent their recovery using conventional investment rationale:
Today: $80,000
End of Year 1: $86,400
“ Year 2: $93,312
“ Year 3: $100,776
In this baseline case, in nominal terms, the portfolio takes less than 3 years to return to its original value of $100,000. This is the scenario often sold to investors by Wall Street and the media.
To be realistic, however, we must demonstrate the devastating affects of taxes and inflation on this scenario. Since our retiree will be living on a fixed income, this is analysis is essential. Let’s assume that the headline CPI is the actual rate of inflation and let’s assume that it will remain at a constant 4% through the duration of our exercise; another charitable theory. Let’s assume a 15% level of taxation since our retiree’s withdrawals are taxed (Trad IRA/401).
We arrive at 8(1-.15)= 6.8% after taxes. 6.8%-4%(headline CPI) = 2.8% real return:
Today: $80,000
End of Year 1: $82,240
“ Year 2: $84,542
“ Year 3: $86,909
“ Year 4: $89,342
“ Year 5: $91,844
“ Year 6: $94,415
“ Year 7: $97,059
“ Year 8: $99,776
“ Year 9: $102,570
Using this more realistic scenario, it will take over 8 years for the portfolio to retain its original value of $100,000. Keep in mind this assumes what will likely be an inflation rate that is much too low, and relative market calm which is also not likely; however, the exercise is still useful for illustrative purposes. The bottom line is that what took 9 months to lose will take almost 9 years to recover. In the case of the 30-something working individual, this is not necessarily a big deal. However, in the case of the retiree, this amounts to a permanently reduced standard of living. For the retiree, life has changed forever; almost overnight.
Imagine then, what happens if you take a situation where the rising retiree has had to take hardship withdrawals to meet housing payments or to fill the gap because student loans were unavailable for his children? Can you see why this was the absolute worst time for the markets to lose 20%? Not only does the retiree find himself set back due to the fact that he’s had to make withdrawals, but in addition he finds that his remaining funds have lost 20% of their value as well.
Hitting the Cookie Jar
In 2007, First Fidelity, which is the largest administrator of retirement plans in the country, reported that early withdrawals had increased 17%. 2008’s numbers will not be available for some months, but there is little doubt they will be much worse. According to Vanguard, another 401(k) administrator, the average hardship withdrawal in 2007 was $6,194. A Vanguard executive indicated that “in many cases individuals are removing the majority of their account’s assets.” If a mere $6,194 represents the majority of many people’s accounts, our baby boomers are in serious, serious trouble. In another sign of the times, the number of early withdrawals by Vanguard account holders rose from around 29,000 in 2003 to almost 50,000 in 2007. 2008 is expected to be much worse as more and more individuals try to stave off foreclosure on homes and meet increasing living expenses.
Borrowing from 401(k) plans has been sold to the public under the guise that they’re only borrowing from themselves much in the same way that the national debt has been explained to people over the years. This could not be further from the truth. When individuals borrow from their retirement savings, they take from that savings the ability to grow during the time that the amount is being repaid. Similarly, when a nation puts purchases on the national credit card, it steals the productivity of the nation. In the case of hardship withdrawals, these sums are rarely repaid, thereby sacrificing future retirement funds and the retiree’s standard of living.
“On Hold?”
In summary, we ask the question of ‘How many retirements have been put on hold, postponed, or ended prematurely just in the last few months?” Imagine this. You just quit your job, you’ve got your gold watch for 30 years of service, and you’re ready for some serious R&R. Then you open your investment statements at the end of June and realize you lost over 20% of your money in a few months time. Suddenly retirement is not so much fun. You were counting on that money to live.
The sad fact is that this could have been avoided. The American public for too long has taken a passive approach to its finances. Big firm brokers will commonly tell people to ignore their monthly statements; that the long run is what matters. While in certain cases this may have some modicum of truth, it doesn’t apply to the rising retiree, nor is it a justification for investor apathy. This approach has cost investors dearly just in the past decade as they were blindsided by the bursting of first the technology bubble followed immediately by the real estate bubble, and now the credit bubble. Perhaps we can finally set aside the passive mindset, become more proactive, and take control over our financial destiny.
Have we finally learned our lesson? Hopefully our recent battle scars will serve us well in this regard. Ask questions. Demand answers.
Disclosure: None.
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This article has 14 comments:
The social mood of the country (and most of the rest of the world) changed in mid-2007. The positive psychology that had existed for many years led individuals, corporations and governments to willingly take on more and more debt (called "credit" by most). As long as borrowers were optimistic, lenders were too and lent more and more dollars. All is fine as long as asset values and incomes are rising and the mode is expansionistic. Interestingly, inflation was low as the global marketplace expanded and foreigners were satified to place their increasing horde of dollars in our debt markets. Something had to be done with this river of cash flow, and the only asset that could be sufficiently levered up to absorb it was the US housing market, which is the largest single asset value in the world.
4 million excess housing units were built, and most were sold, many to real estate "investors and speculators". Many of those who didn't buy the ever more expensive and far too large housing units extracted the maximum equity from their own homes. Now this has all come to an end and the owners and borrowers are facing reality. Most banks have as much of as 50% of their assets in real estate loans, with the collateral for those loans going down roughly 2% per month. Most of these loans are now under water and the borrowers are having difficulty making their payments as other living costs for fuel, food, insurance, property taxes, repairs, etc. continue to increase.
Americans are stretched like a rubber band. It has started to break and the country is drowning in a sea of mortgage debt, credit card debt, automobile debt, etc. This is being reflected in bankruptcies and foreclosures and is naturally spreading to bank failures. The federal government cannot put its finger in all the dikes and most will be allowed to fail, except for a few such as FAN and FRED and the large NY banks and brokerages.
We are facing a 4-6 year downtrend in the markets and in the economy. There is a probability that the stock market will decline to the level that it was in 1974, or below 500. While this seems impossible for all those who have experienced the past 25+ years of a generally uptrending market, it can happen. Cash has been the best performer since 2000.
Face reality. Its not going back to the old highs. Stay away and be very afraid of the stock market if you do not know how to short it.
It hits on all the retirees and soon the be retirees.
I almost never see this type of baseless, moronic speculation on SA. User whoever you are, please take your drivel to Daily Kos, where there are plenty of idiots who like to see this and the lack of logic to appreciate it. I'm just sure that a President sits up at night thinking of how to ruin the lives of working Americans. PLEASE - NEXT TIME YOU COMMENT, TRY TO THINK.
Now it is all speculation. Dividends are low and valuations are high. It's all based on greater fool theory at this point. Consider MSFT. They pay no dividend to speak of. They are too big for anyone to buy out (i.e. their can be no corporate greater fool). Growth is slowing if not going negative in real terms. Why should anyone buy your shares from you? Anyone holding MSFT stock is getting screwed by inflation which is at least 7% and more like 12% if you listen to shadowstats.
Pretty soon people will realize that inflation is here to stay and that the stock market has run out of steam because the US consumer is broke and now the credit card is being shut off.
When this happens, bye bye dow, hello gold and silver. Not if but when. And not very long of a when either. The trap is almost sprung.
1) it is unlikely the dow can recover the lost anytime soon (see Planner's comment above). in fact, i believe the dow may be entering an even higher period of volatility. so a retiree is unlikely to recover lost capital anytime soon;
2) inflation's engines is being ignited by energy increases and the previous declines of the dollar. so whatever the retiree has left will evaporate into an even smaller puddle;
3) the retiree's house, which most were counting on for a significant contribution to the good life after retirement, has dropped in value. if the deflation of housing values stops today, i doubt it will rise again anytime soon; and
4) not against owning gold (i do own some), but you can never count on when the price will increase. it is not a reliable investment vehicle to baseload a retirement plan.
so what to do????
Most people do not need to invest in the sense we have been led to believe in it. All they need to do is to preserve the wealth they already earned so that they can use it when they are no longer physically able to work.
Because fiat currencies are constantly being inflated, you are FORCED to "invest" (which is now nothing more than gambling) else inflation will eat you alive. When you take personal financial risk and actually win once in awhile, the gov't then wants to tax you on your winnings. What a freaking SCAM. Get your wealth into gold. It does not evaporate and ever since the gov't stopped forcing the price to 35/oz, it has rocketed to over 900/oz today, almost 30x gain in the past 35 years. Good luck getting that sort of return on stocks that can go BK. Gold can never BK.
When it's time to spend your gold, pay for things in gold, not dollars. In this way there is no fake capital gains to pay on inflation. That is such a scam I'm surprised nobody is taking out a front page add in the wall st journal stating the fact.
Inflation, hands down is what I worry most about.
What's going up in this market besides not much if anything??
Energy & Precious metals.
What am I going to invest in that will both preserve my wealth and appreciate in the kind of markets we face today?
Specifically, first on that list would have to be to hold physical gold and/or silver. And then maybe throw in some Canadian Energy Trust shares with those excellent dividends or shares from a major energy producing company or energy related service companies, along with some shares from a good major gold miner. Hey, it won't work forever, don't fall in love with it. But right now, it's about the only thing that IS working and I'm sleeping much, much better.