Contents

Preface

Introduction: A Challenging Time to be Retired

Chapter 1: Four Pillars of Smart Investing

Chapter 2: The Risk Zone and Sequence of Return Risk

Chapter 3: Why the 60/40 Stock/Bond Allocation Rule is Wrong for Most Baby Boomers

Chapter 4: What Financial Consultants Have Learned in the 70 Year History of Investment Consulting: 1950-2020

Chapter 5: Retirement Savings Plans

Chapter 6: Target Date Funds and Target Date Portfolios Should Protect Baby Boomers

Chapter 7: Stock and Bond Market Bubbles and What Pops Them

Chapter 8: Money Printing and Inflation: COVID, Cryptocurrencies and More

Chapter 9: Global Debt Crisis

Chapter 10: Gaslighting: Outlandish Outlooks

Chapter 11: Dealing with Economic Recessions, Stock Market Corrections and High Inflation

Chapter 12: Annuities and Other Risk Mitigators

Chapter 13: Living to 100 on Savings, Social Security and Medicare/Medicaid

Chapter 14: Social Security and Medicare/Medicaid

Chapter 15: Reverse Mortgages

Chapter 16: Smart Spending

Chapter 17: Working in Retirement

Chapter 18: Happiness

Preface

Why I wrote this book

I’ve been an investment consultant since 1974. In the early part of my career, I consulted to large defined benefit pension plans, collectively in the $trillions. More recently I’ve focused on target date funds (TDFs), the most popular choice for default investments in 401(k) defined contribution plans. I’ve designed and patented a TDF glidepath that seeks growth for young investors and protection for older investors like baby boomers.

Through research and observation, I became aware that baby boomers are not protecting their lifetime savings. They are investing for growth when they should be investing for safety. This is a serious problem because most of our 78 million baby boomers will spend much of this decade in the Risk Zone where losses can ruin the rest of a baby boomer’s life by reducing lifestyle and the length of time that savings last.

So, I began a crusade  to warn my fellow baby boomers. I wrote articles that were published, but they didn’t seem to be having an effect. I needed to find a way to reach the people I want to warn.

Then in December of 2019 I had a breakthrough. My sister, Kathleen Tarochione, has an extraordinarily successful live streaming video show on LinkedIn and FaceBook. While we were together at Christmas, I shared my concern with Kathy, and she offered to help me by producing a show for baby boomers.

The Baby Boomer Investing Show aired for the first time in February 2020 and succeeded in attracting the audience I hoped for. Since then, we have broadcasted twice a month and created a substantial library of videos and articles.

I decided to pull this library together in this book. Every chapter includes links to Baby Boomer Investing Shows so you can watch the stories come alive. It’s a fun way to delve into  these highly informative and timely topics.

This book is the culmination of 2 years of work. I hope you enjoy it. Please take our warnings to heart. This is an incredibly challenging time to be retired.

Introduction: A Challenging Time to be Retired

It’s usually not true when someone says, “It’s different this time”, but it is true this time:

- Interest rates have never been lower

- The US government has never printed more money

- Stock prices have never been higher

- The wealth divide in the US has never been wider

These are challenges that most baby boomers are not prepared to deal with because most are not educated in finance and investing. Will Rogers said, “Everyone is stupid, but about different things.”

Low Interest Rates

The government is implementing a Zero-Interest Rate Policy (ZIRP) that is discussed in Chapter 9 on the Global Debt Crisis. Unlike retirees of the past, current retirees cannot earn a decent return on safe investments, so they’ve been forced into risky investments like stocks and risky bonds.

Money Printing

Taking on this risk exposure is a trap that will be sprung when inflation  reappears big time, as discussed in Chapter 8. The US government has spent $13 trillion and growing in new money. For perspective, this is more than our 13 largest wars combined. World War II cost $4.7 trillion in today’s dollars. Inflation undermines the value of savings and in this case it will likely pop the stock market bubble.

Stock Market Bubble

Chapter 7 explains why a stock market bubble exists and why inflation will pop it. Inflation forces interest rates to increase. Rising interest rates reduce stock prices. The somewhat good news is that ZIRP will end because the government will not be able to continue it.

The Great Wealth Divide

Although the poor in this country are better off than most in other countries, as we discuss in Chapter 13, the gap between rich and poor is huge, as summarized in the following:

Consequently, there is social unrest around the country like Seattle, Portland and Chicago.   The not-so-rich are demanding more and the government is responding with more free stuff, leading us down the path of Socialism.

Investment Guidance

Baby boomers are the first generation to be responsible for the investment of their savings. Previous generations we’re mostly covered by defined benefit pension plans where employers made all the investment decisions. Unfortunately, baby boomers are invested 60/40 stocks/bonds as we discuss in Chapter 3. This is a mistake for most because baby boomers are in the “Risk Zone”* described in Chapter 2. We provide the “Four Pillars of Smart Investing” in Chapter 1 as a general guide,  plus guidance on dealing with imminent disasters in Chapter 11.

Most importantly, baby boomers should not “stay the course” as they are frequently advised because most are on the wrong course and exposed to serious investment losses at this most critical time in their investment life.  There are no do-overs.

Please Watch This Video

We end each chapter with a link to a video on the topic. The video for this Introduction can be viewed here: A Serious Look Ahead https://www.youtube.com/watch?v=jbEgLesNWz8

* The Risk Zone is the five to ten years immediately before and after a retirement date. Boomers can be irreparably damaged by a significant stock market decline during this period if they have an excessive allocation to common stocks. The consequences of a decline during this time period can be devastating: deferred retirements, part-time employment, shortened life of savings, and reduced standard of living.

Chapter 1: Four Pillars of Smart Investing

Game-changing Tools That Prevent Stupid Mistakes.

- It was easy to be “smart” in the past decade. It will be easy to be “stupid” in this current decade of the 2020s. Smart investors make smart asset allocation decisions.

- 78 million Baby Boomers need to get smart right away, before it’s too late. Many currently are not making smart investment decisions.

- If you use an advisor, it’s smart to trust but verify. 60/40 stocks/bonds is not smart for most baby boomers, although it is the standard answer.

Stupid is as stupid does. Forrest Gump

Everyone is stupid. Only on different subjects. Will Rogers

The critical step in smart investing is realizing what matters most. By focusing on this most important aspect, smart investors spend their time, energy and money wisely, and avoid distractions that take their eyes off the prize of reaching goals. Saving “enough” is the most important action an investor can take. The second most important action is investing it wisely, but this is a distant second. “Save and protect” is a smart mantra.

If you’ve saved enough, it may be best to simply be safe, and protect it. Importantly, there comes a time in most lives when whatever you’ve saved must be “enough” because it’s all you’ll ever have. For those who don’t have a defined benefit pension, that time is when you leave the workforce and begin retirement.

Saving enough is not an investment decision; it’s a behavioral goal. In the following we provide guidance on wisely investing whatever you have saved, with the perspective that it will have to be “enough” by necessity when you enter retirement.

Asset allocation is the most important investment decision. It explains 100% of investment performance -- yes, all of it. Getting asset allocation “right” is the smartest investment thing you can do. It’s much more important than security selection. Stock picking might be more fun, but picking the very best securities doesn’t matter nearly as much as your asset allocation. We discuss smart asset allocation in this article.  We use the decade of the “Roaring 2010s” as a guide for the current decade of the 2020s.

The following periodic chart demonstrates the importance of asset allocation. In 2018 everything lost and in 2019 everything won. The average spread between the best and worst performing asset classes is 32% each year.  Importantly for investor memory and behavior, everything except commodities won over the past decade. Large companies earned 250%, or 13.4% per year on average, while commodities earned nothing.

Focusing on the past decade in the next graph, asset allocation has been important, and it will likely be even more important in this decade. Portfolios with high allocations to US stocks and real estate performed far better in the past decade than those that held commodities. Since most US investors hold US stocks and real estate, they can view themselves as “smart” in the past decade, but the next decade is going to be much more challenging for reasons we discuss in this chapter.  For some, the recent good times are all they have experienced, but it will not go on forever.

Fortunately, there are tools for intelligent investing that develop smart asset allocation. The best tools are easy to use and, most importantly, manage risk in the Risk Zone that spans the 5 years before and after retirement when savings are at their peak, making losses most damaging. Investors can use these tools in their 401(k)s, their Individual Retirement Accounts (IRAs), and their personal accounts.

Most baby boomers are making a serious mistake by not protecting themselves in the Risk Zone. They are on average 60% in equities and 40% in long term bonds, an allocation that lost 30% in 2008.

As discussed in the next section, smart asset allocation is challenging, but can be accomplished with the right tools.

4 Pillars of Smart Investing

Asset allocation is the first pillar of smart investing. It’s designed to achieve objectives with an acceptable likelihood. Allocations are adjusted in response to successes and failures in this achievement. Plus, goals change through time. This financial navigation is dynamic and challenging.

Asset allocation decisions are risk decisions. You need to take a certain amount of investment risk in order to earn the return you need to achieve your objectives. Dr. Frank Sortino, father of Post-modern Portfolio Theory (PMPT), calls this target return the Minimal Acceptable Return (MAR).  This risk decision is called “risk preference” or “risk necessity.”  It should not be confused with market timing, another separate motivation for modifying risk. The risk preference pillar needs to be conditioned on three more pillars:

- Do you have the risk capacity for this level of risk?

- What is the smartest way to take this risk?

- How can you take this risk at the lowest cost?

There are circumstances when you simply should not take the risk it requires to achieve your objectives because you don’t have the risk capacity. In particular, there’s a time in everyone’s life when risk capacity is extremely low because the stakes are as high as they will ever be.  You cannot afford to lose your lifetime savings at this critical juncture in your life, warranting its title as the “Risk Zone” that spans the 5-10 years before and after retirement.

As discussed in the next Chapter, losses in the Risk Zone can devastate retirement lifestyle and reduce the length of time that savings last, even if markets subsequently recover. Sequence of Return Risk is the source of this Risk of Ruin.  Even the wealthy should protect themselves in the Risk Zone because they too have plans that can be ruined, and heirs who could inherit less. The rich can be devastated too; after all, they have a lot to lose.

Smart asset allocation is tailored to achieve your goals, unless you cannot tolerate the required risk, especially in the Risk Zone. If you use an investment advisor, you are most likely invested in a model portfolio, but most models fail to recognize age and the Risk Zone, recklessly striving for an MAR regardless of risk capacity. Fortunately, there are better  models. Recognizing your capacity is the second pillar.

As for the third pillar, the smartest way to take risk when you’re young is to be as diversified as possible: global stocks and bonds, real estate, commodities, etc. Then as you enter the Risk Zone, the smartest way to control risk is with safe assets, like Treasury Bills. Dr. William F. Sharpe won a Nobel Prize for his revolutionary discovery, called the Capital Market Line. The smartest way to control risk is not to add more bonds; it’s to blend a broadly diversified world basket of risky assets with safe assets. Diversification and smart risk control provide the best returns for the risk taken over time.

And the fourth pillar -- being cost conscience -- is simply common sense. Costs reduce returns. Interestingly, the desire to diversify and to keep costs low has recently driven investors to passive index investing, especially in Exchange-Traded Funds (ETFs). Investors are “getting it.”

Beyond the Risk Zone, retirees are best served  by re-risking in order to extend the life of investments. This is contrary to the old rule of thumb that advocates “100 minus your age” in equities. Groundbreaking research by Dr. Wade Pfau and Michael Kitces has revolutionized optimal investing in retirement.

The good news is that today there is financial engineering designed to not lose money and to provide the highest returns for the risk that is taken. Better investing through science.

Why the 2020s decade will suffer a major market correction

Chapters 7 through 9 in this book discuss the threats to investors, especially baby boomers, namely a global debt crisis combined with bubbles in stock and bond prices. In other words, the necessity for risk management is reinforced by the threat of a serious market correction.

Industry expert Lance Roberts, Managing Partner of RIA Pro,  warns:

With debt levels rising globally, economic growth on the long end of the cycle, earnings growth week, valuations high, and potential risk of a recession, the uncertainty of retirement plans has risen markedly. This lends itself to the problem of individuals having to spend a bulk of their "retirement" continuing to work

Yes, not only should you worry about bear markets, but you should also worry about them a lot.

Smart institutional quality investing in the current decade

Individual investors can learn from institutions, with their substantial resources and research. According to FS Investments, institutional investors have performed far better than individuals in the past 2 decades:

Target date funds (TDFs), at $2.5 trillion and growing, are the biggest deal in institutional investing. Individuals can benefit by following the disciplines incorporated in TDFs.  Please read Chapter 6 for more details on target dater funds and their asset allocation glidepaths.

“Don’t stop thinking about tomorrow” by Fleetwood Mac is a song we should all be singing at this precarious time. The tectonic plates of investing are shifting, and we need to be prepared. One group in particular is in serious danger, namely baby boomers.

Conclusion

The smartest investors spend their time, energy and money on what matters most, namely asset allocation. Getting this critical decision right is not easy. Attempts to improve performance results beyond policy returns typically fail, undermining achievement of your goals. Stock selection and market timing are unproductive at best and typically counterproductive. You can win the performance game but fail to achieve your goals.

Smart asset allocation integrates risk willingness with risk capacity and is broadly diversified and low cost. The good news is that there are tools to be smart, and they are easy to use and inexpensive.  These  tools bring the wisdom and disciplines of target date funds (TDFs) to the masses. 401(k) plans have invested more than $2.5 trillion in TDFs and growing. According to a recent study by the Wharton School “the adoption of low-cost target-date funds may enhance retirement wealth by as much as 50% over a 30-year horizon.”

Investment mistakes in this perilous decade of the 2020s could be very costly, especially to baby boomers who should not be gambling their lifetime savings. You may want to work with an investment advisor during this critical time in your life, but you should verify his/her competence by using these tools.  Unfortunately the “60/40 stock/bond Rule” is alive and well, and a mistake for most baby boomers. Trust but verify.

Please Watch This Video

We end each chapter with a link to a video on the topic. The video for this Chapter can be viewed here: Basics:  https://www.youtube.com/watch?v=wXdR_zWXk48

Chapter 2: The Risk Zone and Sequence of Return Risk

- The “Risk Zone” is the 5-10 years before and after retirement

- Because of “Sequence of Return Risk”, risk in the Risk Zone is “Risk of Ruin”

- Baby boomers should protect their investments because they are in the Risk Zone now, but they generally are not protecting.

All investors knowingly take some risk of losing money, but there comes a time in all of our lives when, unless we do something about it, risk of loss morphs into the risk of ruin. We all run the mandatory gauntlet of ruin as we transition from our working lives into our retirement years. Losses sustained during this transition period can devastate lifestyles even if markets subsequently recover. That is why Professor Moshe Milevsky calls this the Risk Zone. The Risk Zone is the five to ten years before and after retirement.  During this period, investors are least able to tolerate adverse market conditions because significant dollar losses in lifetime savings can substantially reduce living standards.

Most baby boomers are unaware of this risk, so it is exceedingly high. It could and should be much lower, as we explain in the following. Unless you feel extraordinarily lucky, you want to protect against “Sequence of Return Risk” that only exists while you are in the Risk Zone. It’s a risk that can and has blindsided many investors. Don’t let this happen to you.

Sequence of Return Risk Defined

The mathematics of investment return is complex when investment withdrawals come into play. Without withdrawals, the sequence of returns doesn’t matter. We can rearrange return sequences in any way we want, and the compound cumulative return is unchanged. Ending wealth is the same regardless of the order in which returns are earned. But if we are withdrawing money, as we are in retirement, the sequence of returns matters a lot. Losses in earlier years can be devastating, while the same losses in later years don’t matter much. Here’s an example:

Managing Sequence of Return Risk

The simplest and most dependable way to manage sequence of return risk is to keep your investments safe during the Risk Zone that spans the five years before and after retirement. This will of course create opportunity costs if markets perform well, but it is a price well worth paying because you only get to do this once. Also, your savings are likely to be at their highest as you transition from working life into retirement, so there is more to lose. “Save and protect” is an exceptionally good mantra for retiring with dignity.

But how should you invest when you’re not in the Risk Zone? The logic embedded in target date funds (TDFs) serves as a guide. Target date funds are more aggressive when you’re young and move to defend as you approach your retirement target date. The problem is that off-the-shelf TDFs are not conservative enough at the target retirement date to defend against sequence of return risk. The average TDF is 50% in equities and 40% in risky long-term bonds, so 90% risky, at the target date. Please read Chapter 6 for information on target date funds.

The Three Stages of Lifetime Investing

There are three distinct investment stages during our lifetimes: (1) Accumulation, or savings, (2) Transition, and (3) Retirement, or distribution. Saving enough is paramount to a retirement with dignity, but retirement can be ruined if savings are lost during the Transition  phase. In other words, investment objectives should change from growing investments during the Accumulation phase to protecting them during the Transition phase. Baby boomers are generally not protecting their lifetime savings in this Transition phase, but they should, as we discuss in the next chapter.

Please Watch This Video

We end each chapter with links to videos on the topic. The videos for this Chapter can be viewed here:

- Lifepath Investing:   https://www.youtube.com/watch?v=j6hEaCskNxU

- 401(k) Scandal :     https://www.youtube.com/watch?v=nIMrGNHgSTg

Chapter 3: Why the 60/40 Stock/Bond Allocation Rule is Wrong for Most Baby Boomers

- The 60/40 Stock/Bond Rule is ubiquitous, and that’s stupid because it’s just not right for everyone, especially baby boomers.

- Risk preference needs to be controlled by risk capacity. Baby boomers should not take the risk inherent in a 60/40 mix at this time in their lives.

- Baby boomers can easily be smarter than 60/40

Most baby boomers are following the 60/40 stock/bond rule, an asset allocation “solution” that has evolved through time and is roughly based on market composition. The total market for equities and bonds is the most diversified, and it is approximately 60%  equities where equities include stocks, real estate, commodities, etc. Consequently, the average IRA (Individual Retirement Account) is invested 60/40, regardless of age. Similarly, the average target date fund is 60/40 near the target date. Investment consultants recommend the 60/40 allocation for reasons described in the next chapter. This really needs to change if for no other reason than the 40% bond allocation is very risky when yields are near zero, as they are now.

The Wrong Course

Baby boomers cannot afford the risk in a 60/40 portfolio because they are in “The Risk Zone” described in the previous chapter. Losses sustained in the Risk Zone can be life shattering, reducing standard of living for the rest of a person’s life. 60/40 lost more than 30% in 2008 and the next time could be even worse for reasons we describe in Chapters 7 through 9.

The Right Course

The primary investment objective of people in the Risk Zone should be to protect their lifetime savings, even if it means missing out on market gains. Safety First is of paramount importance, so the Right Course is to invest mostly in very safe assets like Treasury bills and intermediate term Treasury Inflation-Protected Securities (TIPS). Most baby boomers will not move to this extreme, but they should protect their savings as much as they can, even though the returns on safe assets are currently low. It is better to protect savings than to risk losing them at this critical time. Savings should also be protected against inflation as we discuss  in Chapter 8. Being safe is a challenge.

Ignore Bad Advice

We began this decade with a COVID-induced recession, and we will likely witness a stock market crash and inflation before the decade is over. Inevitably, the advice in these situations is to “Stay the course” which is fine if you’re on the right course. We provide different advice in Chapter 11.   Some recoveries, like the recovery from the Great Depression, can take a long time. It took a decade to recover from the Great Depression. Most baby boomers do not have time on their side for a lengthy recovery.

Please Watch These Videos

We end each chapter with links to a video on the topic. The videos for this Chapter can be viewed here:

- Why 60/40 is Wrong:   https://www.youtube.com/watch?v=PsKGK7IY9ls

- Don’t Stay the Course : https://www.youtube.com/watch?v=7xX5kOkjERk

Chapter 4: What Financial Consultants Have Learned in the 70 Year History of Investment Consulting: 1950-2020

- Baby boomers need to trust but verify. Be critical of high risk like 60/40 stocks/bonds

- Consulting advice has transitioned from risk tolerance to risk capacity. Take only as much risk as you need, and no more

- There’s been an epiphany to age-based portfolios due to target date funds

Readers who are using investment consultants should not blindly accept their advice. Consultants are trained to use certain tools that are evolving all the time. Importantly, the current best thinking for baby boomers is just beginning to be accepted and incorporated.

Investment consulting has a long history that has been marked by innovations occurring about every ten years, as follows.

1952: Modern Portfolio Theory (MPT): 70 years ago

Dr. Harry Markowitz won a Nobel Prize in1990

1964: Capital Asset Pricing Model (CAPM): 55 years ago

Dr. William F. Sharpe won a Nobel Prize in 1990

1986: Modern Investment Theory (Smart Beta): 45 years

Dr. Robert A. Haugen

1991: Post Modern Portfolio Theory (PMPT): 30 years

Dr. Frank Sortino

2006: Target Date Funds: 15 years ago

Pension Protection Act of 2006

2013: Rising Equity Glide Path in Retirement: 7 years

Dr. Wade Pfau and Michael Kitces

In the following, we discuss each innovation, plus the impacts of the 1974 Employee Retirement Income Security Act (ERISA) and the 1986 groundbreaking study on the Importance of Investment Policy, “Determinants of Portfolio Performance.”

It is incredible that “Modern” Portfolio Theory is about 70 years old. It has stood the tests of time and is currently embraced by many consultants. This 1952 breakthrough began to be utilized in the 1970s, and became mainstream 20 years later, demonstrating our natural resistance to change.  Dr. Harry Markowitz won a Nobel prize in 1990 for educating investors on the magic of diversification and the existence of an “Efficient Frontier” that maps portfolios that earn the highest expected return for a given level of risk. The following graph forms the basis for MPT (Modern Portfolio Theory):

Every stock and bond has risk and expected return. Risk is measured as the standard deviation of returns – volatility. Investors will only take risk if the  expected return  is high enough. The graph shows examples of stock and bond risk-reward. The big breakthrough is that combinations of stocks and bonds earn higher returns for the risk, shown along the Efficient Frontier. Diversification is an immensely powerful investment tool.  There is a free lunch in investing; it’s called diversification.

12 years later Dr. William F. Sharpe extended the work of Dr. Markowitz by introducing the Capital Asset Pricing Model (CAPM) that postulated that everyone should want to hold the most diversified portfolio because it provides the highest return-to-risk ratio, called the “Sharpe Ratio.” The most diversified portfolio is the “World Market” of all risky assets in the world, held in proportion to their market values. An integral aspect of the theory is the “Capital Market Line” that states that risk is best controlled with cash. Every investor should want to hold the Market Portfolio, and if this is too risky use cash to reduce risk. The resulting line dominates the Efficient Frontier, providing higher expected returns for the risk.

This risk management breakthrough is not used much by consultants because they prefer to not control risk with cash. However, most consultants use another aspect of the theory, namely alpha and beta. The regression statistics that everyone uses today to evaluate investment performance were first introduced by CAPM.

Mapping Risk Tolerance into Models

In the early days of consulting, MPT was used to map a client’s risk tolerance into a model portfolio, as shown in the following graph.

The original idea of “risk tolerance” is the maximum risk that the client can tolerate because high risk earns high returns.  This approach changed in the 1990s with the introduction of objective-based investing, discussed below. As shown along the curve above, model portfolios are located on the Efficient Frontier. Then risk questionnaires identify investor risk tolerance that is used to find the best model. The “60/40 Rule” emerged from this practice because most mappings gravitate to the middle toward Model 3 in the graph above. The broad use of the 60/40 rule remains entrenched today. The typical investor is 60/40 equities/bonds, so model providers and TAMPs (turnkey asset management platforms) tend to focus on this model.   As I discuss below, the recent introduction of target date funds should change this practice eventually.

1974: The Employee Retirement Income Security Act

About 50 years ago Congress passed ERISA to govern the practices of fiduciaries. This law remains today as the teeth for prosecuting unethical fiduciary behavior. Importantly for consultants, parts of the law reinforce the wisdom of diversification to avoid the risk of large losses. Consequently, buying the entire market became popular as the ultimate in diversification, and index funds were born. The theory stated that you can’t beat the market. But 12 years later the next innovator showed that you can beat the market by concentrating on certain stock fundamentals, and thereby not diversifying.    You have to make big bets.

Dr Robert A. Haugen is the father of factor-based investing, although most don’t know it. A prolific writer, Dr Haugen wrote hundreds of articles and books on identifying investment factors that produce alphas, superior returns. These factors include fundamentals like yield and capitalization, and classifications like industry sector and style. Dr Haugen set the academic profession on its ear with the heresy that broad markets can be beaten. Interestingly one of his biggest critics was Professor Gene Fama, who later went on to create the famous Fama-French style factors. His legacy is the fairly common use of factor-based investing today and the recent “discovery” of “Smart Beta.” Dr Haugen proclaimed that stock markets are “inefficient” meaning they can be beaten, and he made it his life’s work showing how.

Dr Haugen identified the existence of a return premium in minimum variance portfolios, as shown in the next graph.  Today it is called Smart Beta.

It remains unclear at the time of this writing whether factor-based investing will achieve the acceptance of previous innovations. Most factor-based approaches identify a couple factors, like small company and value, and tilt to them regardless of market conditions. The bet is on the same factors all the time. By contrast, Haugen’s factor allocations were dynamic, adjusting through time to the strength of their signals.

1986: The Determinants of Portfolio Performance

In apparent contradiction to Dr. Haugen’s work, a famous study was released in 1986 documenting that asset allocation explained most of investment performance. The allocations to asset classes like stocks and bonds explained virtually all of the performance in pension funds. A careful read reveals that the report is actually about volatility, as measured by R-squared. Asset allocation explained about 95% of the volatility in portfolio performance. Using the same data provided in the article, we find that asset allocation actually explained 100% of performance.

So how does this square with Haugen’s work? Most pension portfolios were not using factor-based investing in the 1980s, and that fact remains today.  Only a few institutional investment firms utilize factor-based techniques, plus the use of dynamic factor allocations has not yet caught on, although some use factor exposures to measure and evaluate risk.

About 30 years ago, Dr Frank Sortino, AKA Dr. Downside, proposed a new way to define risk, and introduced PMPT – Post Modern Portfolio Theory.  Risk in the PMPT world is the possibility that you will not achieve your objectives. Success in the PMPT world is not beating an index; it’s achieving your goals.  Objective-based investing was born, as was the now popular Sortino Ratio.

Dr Sortino wrote two books on portfolio construction designed to achieve objectives and has made his software available for free, including source code. Consultants use a simplified version that begins by solving for a rate of return that will achieve the client’s objective. Dr Sortino calls this the Minimum Acceptable Return (MAR). The MAR is then used to locate a model on the Efficient Frontier, as shown in the graph on the right:

Note the similarity between the old risk-based approach and the new objective-based process. Both use a family of models along the Efficient Frontier. Risk-based uses the horizontal scale (risk) to locate a solution, while objective-based uses the vertical scale (return) to find an answer. This reliance on a handful of models was about to change, as discussed in the next section.

The consulting industry had an epiphany about 15 years ago that is slowly being integrated into consulting practices. Risk is more complicated than volatility or required return.  The epiphany is simple, but especially important – age matters. There is a time in everyone’s life when we cannot afford to take risk. Losses sustained during the Risk Zone spanning the 5-10 years before and after retirement can ruin retirement, even if markets subsequently recover. Target date funds (TDF) are supposed to provide this protection, although most currently do not. As we discuss in Chapter 6, a properly constructed TDF should be no more than 30% in risky assets at the target date, but most are more than 80%.

A TDF follows a “glidepath” that begins with high risk for young investors and reduces risk through time as the target date approaches. The target date in retirement plans is the retirement date. In other situations, the target date is a date that the fund will be liquidated, like the date a student will start school in college savings plans.

TDFs were not very popular before the passage of the Pension Protection Act of 2006, which made TDFs a Qualified Default Investment Alternative (QDIA) in 401(k) plans. Subsequently TDFs have grown to more than $2.5 trillion. They are the biggest deal in pension plans.

The breakthrough for consultants is that a brake needs to be applied to whatever process is used to find a model. That brake is called “Risk Capacity” defined as the limit on what an investor can afford. Investors in the Risk Zone cannot afford much risk.

The disciplines of target date funds are just beginning to be integrated into consulting practices for individual investors, and this could take a long time. The main shortcoming of target date funds is that they are one-size-fits-all. Personalized target date portfolios solve this problem, and lead to models that are simultaneously risk-and-age based, an innovation in model building.

The most recent innovation is about investing for retirees. Dr Wade Pfau and Michael Kitces have conducted extensive research on optimal investing in retirement and conclude that it is best to begin retirement cautiously with no more than 30% in risky equities and bonds, and to gradually increase risk through time. The cautious beginning is to protect in the Risk Zone, and the re-risking is to extend the life on investments. To begin retirement cautiously you need to end your working life the same way with no more than 30% in risky investments. In other words, a U-shaped lifetime glidepath is optimal, with the bottom of the U in the Risk Zone. Couple this with the importance of asset allocation, and you have the current best thinking for investment consulting.

Dr Wade Pfau is a professor of retirement income and a Director of the New York Life Center for Retirement Income and Michael Kitces is a consulting industry luminary.

Conclusion

A lot has improved in 70 years, but not all consultants have evolved. Investment consulting is a credence good like computer technicians and car mechanics. “Trusted advisors” are usually nice people, but not all are financially skilled with the clients’ best interests at heart.  The client is best advised to trust but verify. Consultants are best advised to differentiate through innovation.

There is a litmus test that readers can use. Be critical if you discover that your asset allocation is 60/40 stocks/bonds  and/or you are in the middle of the consultant’s list of model portfolios. Good chance this is not the right risk for you.

Please Watch This Video

We end each chapter with a link to a video on the topic. The video for this Chapter can be viewed here: 70 Year History : https://www.youtube.com/watch?v=-D9S2xxp-TU

References

Brinson, Gary P., Randolph Hood and Gilbert L. Beebower. (Jul-Aug, 1986). Determinants of Portfolio Performance.  Financial Analysts Journal. Vol. 42, No. 4 , pp. 39-44

Haugen, Robert A. (1999). The Inefficient Stock Market: What Pays Off and Why. Prentice Hall

Markowitz, Harry (March, 1952).  Portfolio Selection. Journal of Finance, Vol. 7, No. 1.  pp. 77-91

Pfau, Wade D. and Michael Kitces (12 September 2013).  Reducing Retirement Risk with a Rising Equity Glide-Path.  Working Paper 2324930  on SSRN

Sharpe, William F. (Sep., 1964). Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. Journal of Finance, Vol. 19, No. 3, pp. 425-442

Sortino, Frank A. (2009). The Sortino Framework for Constructing Portfolios: Focusing on Desired Target Return to Optimize Upside Potential Relative to Downside Risk. Elsevier

Chapter 5: Retirement Savings Plans

- Most people who have saved for retirement are invested in several accounts.

- Consolidating savings accounts makes sense because it simplifies management and monitoring.

- It’s important to know the pros and cons of each type of savings account

There’s $30 trillion invested in US retirement savings accounts, broken into 3 broad categories: Defined Benefit, Defined Contribution and Individual Retirement Accounts (IRAs). In the following, we discuss each of these and the types of accounts that fall into these categories.

Defined Benefit Plans: $10 trillion

       Standard Pension: Best deal for beneficiaries

       Pays an annuity based on pay plus years of service

       Dwindling usage, mostly government and union

       All investment risk is borne by employer.

       Keogh: Eugene Keogh established the Self-Employed Individuals Tax Retirement Act of 1962

       For self-employed & unincorporated businesses

       Can be either defined contribution or defined benefit (HR(10))

       Complicated

       Both are governed by the Employee Retirement Income Security Act of 1974 (ERISA).

Defined Contribution Plans: $9 Trillion

       401(k)

       Elective salary deferrals up to $19,500 plus $6500 for over 50

       Many have an employer match

       Most have automatic enrollment, necessitating Qualified Default Investment Alternative (QDIA) that is typically a target date fund

       Employee chooses investments, so bears all investment risk, including QDIA which is not chosen by employee

       Governed by ERISA

       403(b)

       401(k) plan for public school employees and tax-exempt organizations

       May have more limited investment choices

       Might not be governed by ERISA

       457

       401(k) for government employees

       Generally, not governed by ERISA

       All investment risk is borne by the beneficiary.

Individual  Retirement Account (IRA): $11 Trillion

       Traditional

    For individuals

    Contribute up to $6000, plus additional $1000 for over 50

    Can roll over other savings accounts into this IRA

 SIMPLE

    For small companies

    Contribute up to $13,500

    Usually an employer match, like 2%

 Roth, like Traditional except

    Contributions are not deductible, but distributions are not taxed

    Convert from Traditional by paying taxes as if income for the year of the rollover

 Simplified Employee Pension (SEP)

    For companies, especially sole proprietorships

    Contribute up to 25% of pay, but no more than $57,000

       All can be self-directed: More flexibility than Defined Contribution Plans

A Discussion of Defined Contribution Plans and IRAs

The common default (QDIA) in defined contribution plans is a target date fund. There is more than $2.5 trillion of 401(k) assets in TDFs, but despite this popularity, most agree that that they have a serious deficiency – they’re one-size-fits-all. Individual investors in IRAs do not have to settle for one-size-fits-all TDF mutual funds. They can instead manage glidepaths tailored to their needs and circumstances, described as a “Lifetime Asset Management Plan” in the following:

Profit Sharing Plans (not truly savings plans, but discussed here for completeness)

       Traditional

       Discretionary contributions tied to company profits, up to 25% but no more than $57,000

       Like defined contribution, but with no employee contribution

       Employee has investment discretion, so bears the risk.

       Money Purchase

       Employer contributes a fixed percentage of pay, up to 25% but no more than $57,000

       Employee might have investment discretion from limited choices

       Employee Stock Ownership Plan (ESOP)

       Mostly used in non-public closely held companies

       In essence employer contributes shares of the company’s stock in lieu of money.

       Popular for buying out departing employees

Limitations

Save and Protect

The most important thing we can do to secure a comfortable retirement is to save enough. And secondly, we need to protect those savings – to not lose them – especially in the Risk Zone that spans the 10 years before and after retirement.   The following guide shows how much Fidelity advises us to save through life:

The Department of Labor also provides a very useful Retirement Income Calculator we can use to determine savings adequacy and develop a spending budget in retirement.

In reality, whatever we’ve saved as retirement approaches has to be “enough” because that’s all there is. We adapt a lifestyle that our savings can support for a lifetime, as we discuss in Chapter 13.

Conclusion

It’s important that we save for retirement and that we understand our options for the types of retirement savings accounts we use. There is plenty of help along the way. We just have to take it.

Please Watch This Video

We end each chapter with a link to a video on the topic. The video for this Chapter can be viewed here: Retirement Savings Plans : https://www.youtube.com/watch?v=MwG4Y3BCexc

Chapter 6: Target Date Funds and Target Date Portfolios Should Protect Baby Boomers

- At $2.5 trillion and growing. target date funds (TDFs) are the biggest deal in 401(k) plans

- Shamefully, TDFs  do not protect in the Risk Zone because they are designed for profit.

- Individual target date portfolios (TDPs) are much smarter and personalized.

Introduction

Target date funds (TDFs) were first introduced in the early 1990s by Barclays Global Investors (BGI) and were originally used for college savings plans. Eventually, target date funds began to be used for retirement savings plans, especially 401(k) plans. The target date, for example the 2020 fund, is an event date. In the case of college savings plans, it’s the year that a student intends to enroll in a college. In the case of a retirement plan, it’s the year in which a beneficiary intends to retire. Target date funds' asset allocation mix provides exposure to return-seeking assets, such as equities, in early years when risk capacity is higher, and becomes increasingly conservative as time progresses with exposure switched progressively toward capital-preservation assets, such as short-term bonds. This asset movement through time from more to less risk is called a “glide path.”

Adoption

Usage of TDFs remained minimal until 2006, when two major events brought TDFs to the forefront. First, behavioral scientists recommended that 401(k) plans use automatic enrollment to encourage participation. Employees would need to choose to be excluded from the plan, whereas they formerly needed to sign on for the plan. Behavioral scientists were right. 401(k) participation skyrocketed, but this created a new challenge. Many 401(k) participants were either unable or incapable of making an investment decision, so they defaulted to their employers who typically placed their contributions in very safe assets, like cash.  This led to the second major event: passage of the Pension Protection Act of 2006 (PPA).

The PPA specifies three Qualified Default Investment Alternatives (QDIAs) that plan sponsors can use for participants who do not make an investment election: Target Date Funds, Balanced Funds, and Managed Accounts (accounts managed by outside professionals). By far the most popular QDIA has been TDFs.

Subsequent to the PPA, target date fund assets grew from $0 to about $150 billion in just two short years. This set the stage for serious disappointment in 2008 when the typical 2010 fund lost 25%.  As a consequence of this disappointing loss, the U.S. Securities and Exchange Commission (SEC) and the Department of Labor   (DOL) held joint hearings in 2009, and subsequently threatened to regulate TDFs in a variety of ways, primarily by requiring more disclosures. At the time of this writing, these threats remain to be carried out and TDFs have grown exponentially to above $2.5 trillion.

Conflicted Designers

Risk has actually increased since 2008 as funds position for the performance horse race.  Performance wins business and is usually increased by increasing risk. The problem is that beneficiaries want to be protected, especially as they near retirement. Consequently, the profit interests of TDF providers are out of line with beneficiary safety interests. There is a conflict of interest.  .

The main benefit of a TDF for baby boomers is protection in the Risk Zone, but most funds do not provide adequate protection because they are designed by investment management companies. Certain professions should not attempt to invade the provinces of other professions. For example, butchers should not design furniture and geologists should not design toilet seats.

Such is the case with target date funds (TDFs). TDFs should be designed by financial engineers, following the specifications of experts in retirement savings and investments. In this chapter we discuss the differences between TDFs designed by investment firms and those designed by financial engineers.

When TDFs are Designed by Investment Management Firms

Investment management firms are in the business of investing other people’s money for profit, the more profit the better.  Accordingly, their design of a TDF maximizes profits within the rules of TDFs. The only such rule is that the glide path should reduce risk through time, but the amount of reduction is unspecified. On the profit side, the greatest profit is made at the target date because that’s when account balances are their highest. Combining the rules with the profit motive leads to a design with the highest equity allocation allowed at the target date. That highest acceptable allocation is about 60% based on the actual TDFs designed by investment management companies.

The other consideration is how the remainder is invested, basically the amounts in long term bonds and safe assets like stable value. Since fees on long term bonds are higher than those on safe assets, the majority of the balance is in long term bonds.

TDFs designed by investment management companies start out invested mostly in equities for young beneficiaries. This is particularly good for fund companies except there is not much money in these  long-dated funds. The real money is in funds near the target date. These near-dated funds are relatively less risky than long-dated, with 55% in equity, but still quite risky.

Near dated funds are high risk because most of the balance is in long-term risky bonds. They are about 55% in risky equities and at least 30% in risky bonds, so 85% in risky assets in total.  This is much riskier than near-dated funds designed by financial engineers, putting beneficiaries at substantial risk. Be aware that beneficiaries bear this risk, not fund companies.

When TDFs are Designed by Financial Engineers

Financial engineers are trained to design investment risk and reward  tailored to investor specifications. Experts in retirement savings and investments like Dr Wade Pfau and Professor Moshe Milevski say that it is important to not lose beneficiary savings, especially as beneficiaries transition from working life to retirement in the Risk Zone. Financial engineers use a discipline called “liability-driven investing” (LDI) to guard against losses along the glide path, and to protect in the Risk Zone with very safe investment – much safer than the designs created by investment firms. A financially engineered glidepath ends at the target date with 10% in equities and the balance in safe assets like T-bills, TIPS, and stable value.

The Incredible Differences

The following picture summarizes the differences.

Those familiar with target date funds will recognize the glidepath designed by investment companies because it is the path followed by all but a few TDFs. The path designed by financial engineers is the patented Safe Landing Glide Path (SLGP). It is followed by the SMART Fund Target Date Fund Index and the Office and Professional Employees international Union (OPEIU). There are a few TDFs with glidepaths similar  to SLGP, but none with a 12-year history like SMART.

Why This Difference Matters

There is a lot of money and a lot of people in TDFs. More than $2.5 trillion is invested in TDFs by approximately 40 million people. Many of these people are in the Risk Zone and are facing not just the current pandemic but a whole host of disasters as discussed in the next chapter. At least one of these disasters is highly likely to occur as  baby boomers transition through the Risk Zone this decade.

When baby boomers are financially harmed, they become increasingly dependent on welfare programs that could be overwhelmed, as discussed in Chapter 13.

Individuals do Better with Target Date Portfolios

Despite their incredible popularity, TDFs have a serious flaw: they are one-size-fits-all. Institutional investors who are trying to solve this problem have come to realize that the only cure is to personalize glidepaths to each individual, but this is not practical for entire workforces in 401(k) plans.  Consequently, millions of 401(k) participants in TDFs are bonded together on a ride to who knows where, trusting their employers and hanging on the hope that there’s safety in numbers.

Individual investors have an edge over institutional investors. They can use certain aspects of TDFs, like glidepaths, and customize them to their unique needs and circumstances, and they can do so for a very reasonable cost. Individual investors can build their own customized target date portfolios (TDPs).

Target Date Portfolios are Far Better Than Target Date Funds

We all have our individual needs and circumstances that drive our investment decisions. We are different from those in any one-size-fits-all TDF in the following ways:

- Risk tolerance

- Goals

- Circumstances like wealth, health and family

This is where financial planning can help. A “good” adviser can guide an investor to appropriate investment decisions through time using a personalized target date portfolio (TDP).

The TDF model is helpful for this guidance. As described in Chapter 1, the key to a comfortable retirement is to (1) save enough, and (2) keep it. TDFs have elements of this discipline that can be improved upon by individual investors who manage a customized TDP. A wise investor will protect his/her lifetime of savings in the Risk Zone that spans the transition from working life to retirement.

A successful TDP is the result of 3 disciplines:

- Saving enough and spending wisely in retirement

- Making wise risk decisions. This can be distilled down to the “Three Decision Points” discussed below.

- Using a good financial advisor

Saving Enough and Spending Wisely

Much has been written about how much needs to be saved for a comfortable retirement, and how a spending budget can help savings last a lifetime in retirement. There is general agreement that we need to start saving early in life and to try to save 15% of pay each year. Similarly, the “4% Rule” is a popular spending rule in retirement that spends 4% of savings in the first year, and then increases that amount by inflation in each subsequent year. Of course, these rules are typically broken as life events make them hard to follow, but they serve as good guidelines.

Importantly you should develop an investment plan that helps savings last a lifetime, as discussed in the next section.

Three Decision Points

A TDF template is helpful to formulating your TDP risk decisions. As shown in the following graph, there are 3 critical decision points along a glidepath: (A) Risk when you’re young, (B or B’) Risk when you enter retirement, and (C) Risk in retirement. The graph uses equity allocation as the measure of risk. “Equities” should be broadly diversified and include global stocks, real estate and alternatives like commodities.

Decisions about points (A) and (C) – beginning and end of the glide path – can begin by considering somewhere around 100% to start and 45% to end. Point B is the most critical point because it marks the middle of the “Risk Zone” that spans the 10 years before and after retirement. Losses in the Risk Zone can severely reduce lifestyle in retirement because account balances are at their highest level. Most mutual fund TDFs are 55% in equities at the target date, point B. This allocation lost more than 30% in 2008, and the next market correction could be even worse. We recommend the safe point B’, or about 10% in equities, in order to protect savings in the Risk Zone.

These are the key decisions to discuss with your financial advisor

Using a Good Financial Advisor

A TDF is like flying on a commercial aircraft: you’re going where everybody else is going with a bunch of strangers. By contrast, a TDP is like your own private jet, going where you want to go. You’ll need a good pilot to get you there safely.

You could implement your personalized Target Date Portfolio on your own, but you should consider employing a financial advisor for help. If you do, you’ll want to choose the best, remaining aware of the background in Chapter 4.

Please Watch These Videos

We end each chapter with links to videos on the topic. The videos for this Chapter are:

- Lifepath Investing and

- The Next 401(k) Scandal

Chapter 7: Stock and Bond Market Bubbles and What Pops Them

- 9 expensiveness measures indicate a bubble in the US stock market. Don’t be gaslighted into denying its existence. And of course, there’s a bond market bubble too.

- 15 pumps are inflating the stock market bubble which explains why it keeps inflating despite the economy. There’s just one reason for the bond bubble.

- 10 pins are capable of popping the stock bubble. Serious inflation fueled by COVID relief will crash both bubbles if another pin doesn’t pop the bubbles first.

It would appear that nothing can pop the current stock market bubble, but there is one pretty straightforward “pin” that will probably do the job namely rising interest rates. Central banks around the world have embraced ZIRP, zero interest rate policy, but they can’t control long rates and that reality has begun to take place as I write this article. I argue that (1) bubbles currently exist even though we are being gaslighted into denying their existence, (2) there are understandable reasons bubbles continue to inflate despite economic woes, and (3) several pins can pop these bubbles and one is my odds-on favorite.

9 Expensiveness Measures

It’s official. The rebound from the March 2020 crash is a V-shaped recovery and it only took 4 months, which is much quicker than the typical recovery that takes 4 years. And it gets even better. The return on the S&P 500 over the 12 months following the crash is an astonishing 56%!! This is a 3.5 sigma event, very highly significant relative to the 10% average annual return  on the S&P500. For perspective, the Great Depression lasted a decade and had 10 “W” type recovery/loss cycles.

This run-up through March 2021 brings the Buffett Bubble Barometer to its highest level ever at 220%, well above its 80% average. The value of the stock market is now 220% of GDP (gross domestic product).

And there are 8 more expensiveness measures all indicating a stock market bubble. Wall Street is gaslighting us into believing that there is no bubble because they want investors to stay in the market. Please see Chapter 10.  It’s true that most bubbles are confirmed after they pop, but this current bubble is a whopper that baffles most with its tenacity. A bubble exists when prices are far higher than fair value.

Price/earnings ratio (P/E) is among the most popular bubble metrics, with a “fair” historical value of 15. It is currently above 30, and in the territory that has  preceded previous bubble bursts.  And there are other such ratios that are also in bubble territory like those shown by Lance Roberts in the following where red indicates the economic sectors that are overpriced.

Similarly the following picture is an example that uses a family of 4 expensiveness measures, from Jill Mislinski

There is also a bubble in the bond market. Our government, as well as other governments, are implementing a “Zero Interests Rate Policy” (ZIRP), manipulating interest rates to artificially low levels in order to keep borrowing costs under control on our mounting debt. We have a debt crisis. As discussed below, this crisis is one of the pins that could burst the stock market bubble. The bond market bubble exists because our government wants it to exist. The reasons for the stock market bubble are more complex and varied.

15 explanations for the stock market bubble

I can think of 15 reasons for the current stock market bubble, most of which are wishful thinking.

1. Investors believe that vaccines will cure the pandemic quickly, and

2. Earnings will soar in an economic recovery like no other

3. The Federal Reserve will support stock and bond markets, dumping $trillions

4. Low interest rates cause high stock prices. This is the reason that most investment firms use. They must live with the counterpoint that increases in interest rates will reduce stock prices.

5. Investor greed:  FOMO is fear of missing out

6. Investor euphoria: Hopium is the drug that gives hope in a bright future

7. Huge foreign demand for US securities. Foreigners fear devaluation of their currencies and view the US as “the cleanest dirty shirt in the laundry basket.”

8. 92 million Millennials believe markets only go up and are actively trading on Robin Hood, Robos and the like

9. The FAANG Stock phenomenon where investors believe mega companies will perform well regardless of the economy.

10. Apple is worth a $trillion and Tesla is worth more than their competitors combined

11. The election. The stock market is up so far since Joe Biden took office

12. A belief that amateurs can beat Wall Street with short squeezes on the likes of GameStop and silver.

13. Stock buybacks capitalize on low borrowing costs.

14. SPACs: Special Purpose Acquisition Companies

15. IPOs: Initial Public Offerings

10 pins capable of bursting bubbles

The laws of physics limit the size of bubbles – they all burst when overinflated. They can burst on their own, but most of the time some event triggers a burst, after which everyone agrees that there was a bubble.

10 Threats

1. COVID monetary cost

2. Inflation

3. COVID human loss

4. Global debt crisis

5. Trade wars

6. Nuclear threats

7. Social Security bankrupt

8. Medicare bankrupt

9. Real estate bubble

10. Social unrest caused by wealth divide

My pick is  a combination of the top 2 – the costs of COVID relief combine with other money printing to  create serious inflation, maybe even hyperinflation, that in turn forces interest rates to increase.

Rising Interest Rates

Any one of these threats could burst the bubbles, but I think the following scenario is likely:

1. Interest rates will rise because:

a. Creditworthy foreign governments like China are paying higher interest. 10-year Chinese government bonds currently yield more than 3%, more than twice US Treasuries. And some countries, like Brazil, are paying more than 9% on their 10-year governments.

b. Money printing continues to run amuck and will cause rampant inflation, maybe even hyperinflation. See my upcoming article on the impact of $13 trillion in new money.

2. Stock prices will fall because forecasted earnings will be discounted at a higher rate and higher bond yields will entice investors back to bonds.

3. The government will be forced to monetize the debt in order to pay interest, creating a debt spiral

Others Agree

Several respected investment authorities agree that bubbles will burst soon. Here are a few examples of recent videos:

- Jeremy Grantham: https://www.youtube.com/watch?v=RYfmRTyl56w&feature=youtu.be

- Harry Dent  https://www.youtube.com/watch?v=lg51JrFpLzk makes the brave prediction that the stock market will crash in April 2021

- Ron Surz  https://youtu.be/n9QDdtD5wyc

We might be Cassandras, someone whose accurate prophecies are not believed. See https://en.wikipediasorg/wiki/Cassandra. Do you believe these prophecies?

Conclusion

Baby boomers should be moving to protect themselves. Most of our 78 million baby boomers will spend much of this decade in the Risk Zone spanning the 10 years before and after retirement. Losses in the Risk Zone can make remaining lifetimes far less comfortable. The odds of avoiding a market crash in this decade are incredibly low.

Please Watch These Videos

We end each chapter with links to videos on the topic. The videos for this Chapter are:

- Ten Threats Facing Investors :  https://www.youtube.com/watch?v=vb44OnTumyw&t=51s

- The Stock Market Will Reconnect with the Economy :   https://www.youtube.com/watch?v=cC2F32Zn4Jw

- The Cost of COVID : https://www.youtube.com/watch?v=A2Wy3YFr_VQ

Chapter 8: Money Printing and Inflation: COVID, Cryptocurrencies and More

- As of March 2021, COVID costs totaled $5.2 trillion. World War II cost $4.7 trillion (in today’s dollars).

- All-in money printing totaled $13 trillion: $5.2 for COVID + $4.5 for quantitative easing + $3 for infrastructure. Mountains of money cause inflation

- Inflation causes increases in interest rates, lowering bond prices

- Increases in interest rates cause reductions in stock values

All-in spending was approaching $13 trillion  as of mid-2021. That’s more than the US spent in its 13 most expensive wars combined. We use wars because they’re the most expensive things we can think of. Money printing for Quantitative Easing (QE) appears to have worked, so the plan is to load on a bunch more paper money. Is there no limit?

We start with a look at recent COVID costs and then expand to the bigger picture.

President Biden’s $1.9 trillion American Rescue Plan is the third dose of economic COVID relief bringing the total to $5.2 trillion, which is about 25% of GDP (Gross Domestic Product). It’s huge. $5.2 trillion is the total cost of all our wars since 2001, and is greater than even our most expensive war in history, World War II.

Many believe that all this relief is simply spending our previous tax payments, but the truth is that our government  is creating new money, spending future tax payments, and distributing it widely as summarized in the next graph.

Approximately $1 trillion out of $5.2 trillion has been paid directly to taxpayers in the form of personal relief checks. The remaining $4.2  trillion has paid for vaccines, unemployment, and other purposes. Controversially, this newest package is loaded with what is called “Pork” – unrelated applications -- as shown in the following.

All-in Spending

The general sentiment so far is that this relief is welcome and good, but there is legitimate concern about its impact on the US dollar, namely inflation. For example, there is a lot of concern about the recent increase in the yield on 10-year government bonds, from 0.5% to 1.7%.  Rising interest rates mean lower bond prices and can lead to lower stock prices, as discussed in this chapter.

COVID spending comes on top of spending for quantitative easing and infrastructure. The following graph puts this money printing into perspective.

Inflation on the Horizon

The US has jumped in with both feet in providing COVID relief. We are spending more than any other country, including Japan, the acknowledged pioneer of liberal money printing. We’ve spent 25% of GDP so far.

Demand-pull inflation occurs when too many dollars are chasing too few goods, which is a real possibility. The money supply normally grows  about 7% per year but quantitative easing (QE) of more than $4 trillion has increased money supply by 14% per year over the past decade. The $5 trillion in COVID relief increases the money supply by 27%  and does so very quickly – the floodgates are open.

The government doesn’t actually run the printing presses to create all this new money. The Treasury issues bonds. Note that your relief check says “US Treasury.” Under normal circumstances there are plenty of buyers for these bonds, including foreign governments like China and Japan, but these are not normal circumstances, so the Federal Reserve is buying most of the Treasury’s new bonds.

Modern Monetary Theory (MMT) argues that the government can solve economic problems by printing money until it causes inflation, at which time taxes need to increase to rein in that money. Quantitative Easing did not bring inflation as measured by the Consumer Price Index (CPI), so that experiment has been declared a success, but the reality is that QE did inflate stock and bond prices, so there was inflation but not in the usual metric. By contrast, much of the COVID relief money will go directly into the hands of the consumer, so CPI will increase. This time we’ll actually see inflation.

QE dug the US economy into a monetary hole but avoided setting off inflation alarms. COVID relief turns the corner and heads us squarely into CPI-measured inflation.

Many see deflation ahead rather than inflation. There are plenty of deflationary forces in place, as shown in the following picture, but these will eventually become dwarfed by the mounds of money pouring into the economy. It could take a while, but inflation will eventually dominate.

According to a recent Bank of America survey of investment professionals, “A net 93% of fund managers expect higher inflation in the next 12 months, up 7% from the prior month’s survey and an all-time high.”

Federal Deficit Spending

Before COVID the federal government annual spending deficit was $0.9 trillion. COVID and planned infrastructure spending creates a ninefold increase in the deficit, as shown in the following picture.

If a corporation borrowed a million dollars it would pay a negotiated interest rate. If it borrowed 9 times that amount, the negotiated interest rate would increase.  The Federal Reserve attempts to keep this increase from happening, but the laws of economics will eventually prevail.

Increasing Interest Rates

Ibbotson Associates popularized a formula for bond yields, namely inflation plus a risk premium. Real (above inflation) bond yields should be positive, or something is wrong. Something has been wrong with the government’s Zero Interest Policy, or ZIRP. The Fed has manipulated interest rates to keep them low in order to keep interest on government debt low, but this manipulation cannot move beyond short maturities to longer maturities. The market will price long term bonds and it will price them to earn a premium above inflation. Interest rates will rise, and this will topple the entire “House of MMT-ZIRP Cards.” As discussed in the next chapter, the world is in a debt crisis that cannot afford to pay higher interest.

Protection from Inflation and Bursting Bubbles

Stock and bond bubbles are discussed in the previous chapter, Chapter 7. In normal situations, investors can protect themselves from bursting bubbles by moving to the safety of cash, but inflation fears argue against this move. “Safe” in these conditions is hedged against inflation, like the following investments.

Inflation protections

•       Precious metals, especially gold

•       Cryptocurrencies like bitcoin

•       TIPS: Treasury Inflation-Protected Securities

•       Inflation hedged stocks like materials & staples

•       Commodities, including energy & food

•       Some real estate, like farmland

•       Some foreign stocks

Is it Possible That We’ve Been Conned?

The popular TV series The Hustle follows the exploits of a team of con artists. Each episode follows a pattern – the rules of the professional con. This pattern describes the path to printing a mountain of money as follows.

•       The “Mark” in this con is the United States, specifically members of Congress. The “Grifter” is China that is caught in the Thucydides’ Trap, and seeks to be number one. And the “Shills” are U.S citizens, who mostly support big spending.

•       The stages of the con progress as follows:

1)    Foundation  ( identify vulnerabilities): Congressional members are greedy and mostly focused on getting re-elected.  Voters want free stuff like healthcare and education and relief checks.

2)    Approach: Create a “theory” that liberates spending from a budget. Money printing is justified by “Modern Monetary Theory” (MMT) – print all you want. Free stuff makes voters happy.

3)    Build-up: Following Japan’s lead, the US launches Quantitative Easing (QE) in 2008 to head off a recession, printing more than $4 trillion.

4)    Pay-off or convincer: QE works!! The recession ends quickly, the stock market enjoys its longest recovery and inflation is subdued.

5)    The "hurrah": A sudden manufactured crisis or change of events forces the victim to act or decide immediately. The COVID pandemic breaks out, originating in China.

6)    The sting: Congress approves another $5 trillion in COVID relief plus President Biden plans to spend at least another $2 trillion on infrastructure and other projects. So, $11 trillion in new money (counting QE), which may be enough to bring hyperinflation.

Conclusion

Unconventional times require unconventional thinking.

Monetizing $5.2 trillion in COVID relief increases our money supply by 27% and comes on top of $4.5 trillion in QE. Add another $2 trillion in planned infrastructure spending and we have $13 trillion in new money, which is a 35% increase in paper money in circulation and 60% of GDP. It’s a lot of paper. The total cost of our 13 most expensive wars is $10 trillion.

Paper money is called “fiat currency” because it only works if we all agree it works – by fiat. Recent interest in alternative money like gold and cryptocurrencies is evidence that some are losing confidence in fiat money. Inflation is becoming a big concern.

Inflation will trigger bursting of stock and bond market bubbles, but a run to safety needs to consider the eroding effects of inflation Safety needs to be sought in inflation protected investments.

$5.2 trillion in COVID relief will tip us over the monetary edge. We’ve been ”poking the bear” testing to see how much money can be printed without repercussions. The bear is awake now and about to attack. Baby boomers need to be especially concerned because their lives might never be the same if they don’t protect now. Younger investors have a shot at recovery.

The advice in the Talmud is worthy of consideration, namely: Let every man divide his money into three parts, and invest a third in land, a third in business and a third let him keep by him in reserve.

With the current inflationary threats, Talmud-based allocations look something like the following, where the real estate allocations include your home.

Please Watch These Videos

We end each chapter with links to videos on the topic. The videos for this Chapter are:

- Cryptocurrencies :   https://www.youtube.com/watch?v=k2tPLpp1fIA

- Unconventional Thinking : https://www.youtube.com/watch?v=hzzpCfVkY7U

Chapter 9: Global Debt Crisis

- Global debt is officially $184 trillion, which is 225% of global GDP. This is $86,000 for every person in the world, which is 2.5 times annual income.

- We estimate that official figures are understated by a factor of 2.5, so debt is actually $460 trillion, which is 560% of GDP and $215,000 per person.

- These numbers are astronomical, raising the risk of economic blowback once interest rates and inflation rise, as they eventually will.

Official World Debt

The International Monetary Fund reports that global debt has reached a record high, raising serious implications for the global economic outlook. The worrisome details include:

- Global debt has reached an all-time high of $184 trillion in nominal terms, the equivalent of 225 percent of GDP in 2017. On average, the world’s debt now exceeds $86,000 in per capita terms, which is more than 2½ times the average income per-capita.

- The most indebted economies in the world are also the richer ones. The top three borrowers in the world—the United States, China, and Japan—account for more than half of global debt, exceeding their share of global output.

- The private sector’s debt has tripled since 1950. This makes it the driving force behind global debt. Another change since the global financial crisis has been the rise in private debt in emerging markets, led by China. At the other end of the spectrum, private debt has remained very low in low-income developing countries. See the section below on “Why Worry.”

- Global public debt, on the other hand, has experienced a reversal of sorts. After a steady decline up to the mid-1970s, public debt has gone up since, with advanced economies at the helm and, of late, followed by emerging and low-income developing countries.

The Visual Capitalist breaks global debt out by country as follows:

The “Real” numbers are much bigger

The official numbers are understated. In this article, I show that the official US figure of $20 trillion in public debt is 5.5 times less than the actual debt of $110 trillion, which is 390% of GDP. Public debt in the US is about one-third of total debt, so real total debt is 2.5 (5.5 X 1/3 +2/3) times higher than the official number

Using this 2.5 times multiplier applied against the official $184 trillion, global debt is really more like $460 trillion which is 560% of Global GDP. It’s beyond belief.

Why Worry?

Debt brought the world to its knees in 2008. Paradoxically, disaster was circumvented by doubling down with even more debt, deferring the consequences to sometime in the future. That future is rapidly approaching. In The Coming Global Financial Crisis: Debt Exhaustion, Charles Hugh Smith observes:

The global economy is way past the point of maximum debt saturation, and so the next stop is debt exhaustion: a sharp increase in defaults, a rapid decline in demand for more debt, a collapse in asset bubbles that depend on debt and a resulting drop in economic activity, a.k.a. a deep and profound recession that cannot be "fixed" by lowering interest rates or juicing the creation of more debt.

Even if it’s not the cause, debt has a history of predicting market crashes. In A Brief History of Doom: Two Hundred Years of Financial Crises author Richard Vague demonstrates that the over-accumulation of private debt does a better job than any other variable of explaining and predicting financial crises. The 2008 crash is a recent example.

A number of other economists agree. Steve Keen, an economics professor who heads the School of Economics, Politics and History at Kingston University, outlines a persuasive case in his book “Can We Avoid another Financial Crisis?” for why rising private debt tops the list of possible triggers for the next financial crisis and recession.

Consider private debt with the current gargantuan public debt and it’s clear that we need to worry about a double whammy of a market crash exacerbated by stagflation, or even hyperinflation. The next recession will also be compounded by the toppling of the share buyback dominoes.

Much of the “real” debt is for government promises that cannot be kept -- Medicare in the US, for instance. These are promises that the people have made to themselves, so it’s conceivable that some generation will simply refuse to pay, causing social disorder.

Foreign affairs may bring trouble, too. The so-called Thucydides’ Trap is a related threat that sees the US and China heading toward war, and everyone’s hoping that it might be a relatively benign conflict like the Cold War that was waged with Russia, or that it might end with a battle using only tariffs as weapons. Yet the great Greek historian Thucydides foretold that irresistible rising forces (like China) would collide with immovable superpowers (like America). Nouriel Roubini, known for his correct warnings of the 2008 recession, believes that the China-US trade war will push the US economy into recession.  It doesn’t help that China is one of America’s largest lenders. There’s a good chance that China’s US loans will be withdrawn, or no future loans will be made, leaving the US with limited funding sources. As discussed in the previous chapter, most of the Treasury bonds issued in 2021 have been purchased by the Federal Reserve  rather than foreign governments.

Some say that the world has bigger problems to worry about like the possible use of nuclear weapons, and that’s true. No one knows which threat(s) will send the world into turmoil or when it will happen, but we do know that if something cannot go on forever, it will end. All we can do is prepare as best we can.

These Bills Will Not be Paid

The official estimate is that every person on the planet owes $86,000 but we estimate that the actual number is around 2.5 times that amount -- $215,000 per person, which is more than 6 times average income per capita. In other words, every person on the planet owes 6 years of labor. No one cares at the moment, partly because no one intends to pay their share, but mostly because we choose to deny the problem’s very existence.

The world economy is running on the fumes of delusory borrowed money, playing an outlandish game that will not end well. We owe each other money that won’t be paid in today’s dollars. That’s why crypto currencies were invented. Fiat money only works if we all agree to honor it; otherwise, it’s just pieces of paper. US currencies were debased  in 1971, when they were taken off of the gold standard and replaced by “In God We Trust.” Now debasing means printing money, or monetizing the debt. Lenders lose when borrowers control payment values.

Signs of weakening credit quality are also appearing in China, where 2018 was a record year in corporate bond defaults, and 2019 was even worse.

Concerned savers can trust a yellow mineral (gold), lines of code (crypto currencies), or baskets of non-US currencies.  Economist James Rickards estimates that if gold became the world currency standard its price would rise 700% to $10,000 per ounce from the current $1400 per ounce. If gold is your preference, you might want to invest in the countries that produce the most of it, namely China and Australia.

Modern Monetary Theory

Central banks around the world are fighting the debt fire with gasoline. In the $22 Trillion Question, Institutional Investor magazine questions the validity of MMT that advocates unlimited borrowing, describing this theory as “refuting the laws of macroeconomic gravity.” The late actor and Senator Fred Thompson humorously explains the folly of MMT in this video.

But Research Affiliate’s Chris Brightman says heterodoxical MMT is here to stay (until it breaks), “partly because it promises to help reverse wealth inequality, which conventional monetary policy has partly fueled.” Also, Nathan Locke of Economic Justice argues that MMT is just fine – the problem is how it’s used; government debt is just a meaningless ledger entry with offsetting financial assets on the other side of the ledger. Debt purchases assets so it’s a wash. “Debt” in this context is borrowed money as opposed to the value of promises like Medicare and Social Security.

But something is awry when in June of 2019 government debt around the world was priced at negative yields and central banks were signaling more easing. How crazy is that? Investing is the idea that you delay consumption now for consumption later in the expectation that your future consumption will be higher. This is guaranteeing delayed consumption now for lower consumption later. As a consequence, gold prices broke through $1400 per ounce and many saw it heading toward a historic $1800 high. It would appear that investors are scared, as they should be.

Altogether, a jaw-dropping $13 trillion in global government debt—a new record—was offering sub-zero yields in June 2019. Investors are guaranteed to end up with less than the bond’s principal amount if held until maturity. There are no “safe investments,” so it’s a dreadful time for everyone who’d like to protect their savings; investments with guaranteed losses are not safe.

Negative yields have driven investors to gold as a safe harbor and as providing the prospect of at least maintaining value. Central banks are also loading up on gold, recognizing that the imminent liquidity trap will render further actions ineffective; the game is ending.

The world is on track to suffer debt exhaustion, since there is presumably some limit to how much borrowing the world economy will accommodate. No one knows when the debt spiral will end, but it’s a virtual certainty that it will not end well.

As described in Chapter 7, the U.S. stock market has been in a bubble that refuses to pop for years. Martin Armstrong, economic forecaster, sees the U.S. stock market as “the cleanest dirty shirt” in a world laundry basket headed for ruin. In July 2019 Armstrong predicted: With so much of the rest of the world beginning to succumb to the arriving global recession, capital is fleeing towards the relative safety and positive returns offered by America’s financial markets. As a result, I see the US stock market continuing to power higher from here, with the Dow Jones Industrial Average potentially tagging 35,000 by 2021.

Old folks have the most to lose because they won’t be able to recover. According to Edward Siedle, 401(k) expert, Too frail to work, too poor to retire will become the “new normal” for many elderly Americans.

How to Protect Yourself

“You cannot fix a problem that you refuse to acknowledge.”
― Margaret Heffernan, Willful Blindness: Why We Ignore the Obvious at Our Peril

Sticking our collective heads in the sand and hoping the problem goes away is not a solution. But no politician who wants to stay in office will acknowledge the problem and deal with it. They want to delay the day of reckoning, but this delay cannot be indefinite. We need to protect ourselves because our leaders will not.

Treasury bonds will not provide the safety that they have historically offered because they’re at the heart of the problem: financing the debt.  As documented in the previous chapter, a well-diversified portfolio of inflation-protected assets will help, like Treasury Inflation Protected Securities (TIPS), commodities, real estate, gold and cryptocurrencies.

Please Watch These Videos

We end each chapter with links to videos on the topic. The videos for this Chapter can be viewed here:

- Our Real Debt : https://www.youtube.com/watch?v=GPYtpC9_IcA

- COVID Lessons :  https://www.youtube.com/watch?v=WncE5jtTaB4

Chapter 10: Gaslighting: Outlandish Outlooks

- The word “Gaslighted” means manipulated into not seeing reality

- As evidenced by forecasts of 2021 security returns, investors are routinely gaslighted into believing the future is bright

- The reality is that market corrections are highly likely in this decade of the 2020s

Oxford Dictionaries named “Gaslighting” one of the most popular new words in 2018.  The word originated from a 1938 mystery thriller written by British playwright Patrick Hamilton called Gas Light, made into a popular movie in 1944 starring Ingrid Bergman and Charles Boyer. In the film, husband Gregory manipulates his adoring, trusting wife Paula into believing she can no longer trust her own perceptions of reality. Accordingly, gaslighting is the act of undermining another person’s reality by denying facts, the environment around them, or their feelings. Targets of gaslighting are manipulated into turning against their cognition, their emotions, and who they fundamentally are as people.

We are routinely gaslighted

Investors are routinely gaslighted by the investment management community (Wall Street) into thinking that there are no bubbles in stock and bond prices, that the Fed is our savior, and securities markets will always go up. Wall Street wants to control the $50 trillion in baby boomer hands.

For example, market forecasts in January 2021, in the heat of the COVID pandemic,  were uniformly positive and not too far from historical averages, although they generally acknowledged the pandemic. Some even forecast double digit returns in 2021.

By contrast a few were forecasting serious losses on the order of 50%. How can these outlooks be so radically different?

What is happening

Most investors are  inundated with webinars and articles that go into great detail to explain why the decade of the 2020s will be good for investors. Many of the presenters have PhDs so we think they’re smart. We watch and read, and forget about the current threats because they are not mentioned. Earnings are the focus. Investors buy the future earnings streams of companies, discounting those earnings back to the present in order to get a “fair” price. We’re told that companies with depressed earnings due to the pandemic will   quickly recover. Plus, the Fed has promised to keep interest rates near zero for at least 3 years, so surging earnings are discounted at an incredibly low rate to produce prices that are significantly higher than today’s prices. It’s all very rosy.

It's important to keep the incentives for these reports in mind. Wall Street gets paid on assets under management – the higher the stock and bond market rises, the more they earn. Wall Street has to gaslight us if they want to maintain their luxurious styles of living . It’s like the research report that says sugar is good for you, sponsored by the Sugar Institute.

The reality

There are plenty of reasons  to be concerned about the securities markets and the economy, most of which are discussed in Chapters 7 through 9. There is a high probability of large losses in stocks and bonds sometime in this decade. No one knows when or how big the losses will be but ignoring the risks can be very costly especially to baby boomers.

We are being brainwashed – gaslighted – into ignoring current threats; into believing that these threats are not real. As long as markets keep going up, our gaslighted “misperceptions” are confirmed – all is right with the world.  Feel had?

Please Watch These Videos

We end each chapter with links to  videos on the topic. The videos for this Chapter can be viewed here:

- A Serious Look Ahead : https://www.youtube.com/watch?v=jbEgLesNWz8

- The Rest of the Story : https://www.youtube.com/watch?v=MtiuJx0_LEo

Chapter 11: Dealing with Economic Recessions, Stock Market Corrections and High Inflation

Investors fear “Market Corrections” and often equate them to “Economic Recessions”, but as you’ll read in this chapter, the two are not the same. In fact, one can occur without the other. The third investor fear is ”High Inflation.” In the following we discuss each fear, its current threat, and how to protect against it.

Definitions

The National Bureau of Economic Research (NBER) defines a recession as "a period of falling economic activity spread across the economy, lasting more than a few months." The NBER is the private non-profit that announces when recessions start and stop. It is the national source for measuring the stages of the business cycle. In other words, we have a “recession” when the NBER says we have a recession. That said, the common, unofficial, definition is a decline in GDP growth that lasts 2 quarters or more. In a nutshell, a recession is a reduction in economic activity

A market correction is defined as a 10% drop in a stock market index, and the S&P 500 is the customary index for this determination. A market correction is also known as a bear market.

High Inflation, also known as Galloping Inflation, occurs when prices increase by more than 10% in a year. Increases in the Consumer Price Index (CPI) for all goods is the common measure of price increases. By contrast, Hyperinflation is much more serious, and is defined as a price increase of 50% or more in a month.

Cause and Effect

There is some debate about whether recessions cause market corrections or market corrections cause recessions. The data favors the latter – market corrections cause recessions – because bear markets have generally preceded recessions. Some say that stock market behavior is a leading indicator of economic activity, but this is mostly semantics. Reductions in wealth caused by market corrections trigger less spending, which slows economic activity. Dr Robert Haugen was among the first to identify this causality. Here’s the history of the sequence of bear markets relative to the start of recessions:

Recession

Timing

Bear Markets

Loss %

Time period

Follows

Bear

83

1929-1932

45

2000-2002

43

1970s

29

late 60s

Concurrent

51

2007-2009

No

Recession

30

Oct-87

22

early 60s

22

late 40s

The Covid-induced recession of 2020 triggered a single month market correction in March that was quickly reversed largely due to the intervention of the Federal Reserve. It’s conceivable that a delayed market correction will happen after the economy recovers since the stock market disconnected from the economy. Time will tell.

Economic Recession

Effects

According to The Balance, recessions cause:

- Increase in unemployment. The US jobs report for April 2020 brought sobering news: The US lost 20.6 million jobs since mid-March, resulting in an unemployment rate of 14.7%, a level not seen since the Great Depression in the 1930s.

- Consumer purchases fall off

- Businesses go bankrupt

- People lose their homes (Home prices fell 10% in 2008 but housing gained about $2.5 trillion in value in 2020 — the most in a single year since 2005, according to a  Zillow analysis )

- Young graduates cannot get a good job

A recession becomes a depression if it lasts two or more years.

As the Federal Reserve moves to stabilize the economy with fiscal and monetary stimuli, inflation can result, as it did in the 1970s when the US suffered from “StagFlation”,  the word for economic stagnation combined with high inflation .

Current Threats

Economic growth in the US had slowed from 3.8% in 2018 down to 2.4% in 2020, and then the Covid pandemic brought an annualized decline of 31.4% (-9% unannualized) for the second quarter of 2020 but quickly recovered in the following quarter. The effects of Covid are expected to be felt for several years.

According to economist Robert Dieli, the triggers for a recession are:

- Instability introduced by a shock, like the Covid pandemic, retaliation from a rogue nation like Iran or North Korea, or a dirty bomb.

- Sustainability of a slowdown, like a squeeze on supply chains associated with trade wars, especially with China

- The Fed may have used up all of its ammunition for averting a recession. Interest rates can’t go much lower, and signs of stress have showed up in the Fed funds rate.

Defenses

CNBC recommends these 6 defenses.

1. Don’t panic. Make sure that you have the risk capacity and horizon to weather the storm.

2. Take stock of your personal life. Is your job secure? Can your family live without an income for a reasonable time?

3. Make a plan. How will you react to the next recession

4. Move to cash. This is very much a market timing decision.

5. Don’t run up your credit cards. You may find that you can’t pay them off.

6. Recognize that recessions are not the end of the world.

Market Correction

Effects

The primary effect of a market correction is investors become poorer because they lose money. Consequently, they spend less, so economic growth slows. The consumer is key to economic growth.

There’s one group of people who suffer the most from a market correction – those who are in transition from working life to retirement. This group has their lifetime savings at risk. There are 78 million Baby Boomers in the Risk Zone. Losses in the Risk Zone result in reduced standards of living and a reduction in the length of time that savings last, even if markets subsequently recover.

Current Threats

As discussed in Chapter 7, stock and bond markets are in a bubble in mid-2021.  The chances are good that these bubbles will burst in the decade of the 2020s.

Defenses

The best defense is moving to safety, like US Treasury Bills and Treasury Inflation Protected Securities (TIPS). For many this move is market timing, which most agree is hard to do right because entails a second decision, namely when to get back in the market.

For some this move is “risk management” rather than market timing. People in the Risk Zone should be protecting their assets regardless of their market outlook. By protection we mean 70-80% in Treasury Bills and TIPS. Once they’re safely through the Risk Zone investors can plan to re-risk to extend the life of their savings.

But there’s another consideration. Treasury Bills will not be a safe investment if we suffer serious inflation rendering cash less valuable. Inflation is our next topic.

Inflation

Effects

Inflation undermines the purchasing power of what is called “fiat money”, namely cash. A loaf of bread would cost 50% more following a 50% rise in inflation, but most don’t believe inflation can exceed 13% because that’s as high as it has ever been. In Inflation, When Art Thou, Professor Craig Israelsen suggests that historical inflation ranges set the bounds for future ranges, but that’s just not true. A few years ago, the Cato Institute released its working paper on “ World Hyperinflations.”

How bad can inflation become? The Cato Institute working paper examines the 56 occurrences of hyperinflation across the globe. The worst of the worst was 200% per day in Hungary from August, 1945 to July, 1946.

Many believe that we will see serious inflation around the globe because we cannot afford the humongous debt we’ve incurred.  Inflation benefits the borrower at the expense of the lender. For a painfully funny borrower perspective, see the “Saturday Night Live” skit at China Sin-Drome.

Current Threats

As discussed in Chapter 8, the US government has embarked on a money printing spree approaching $13 trillion, which is more than was spent on our most expensive wars combined, and as discussed in chapter 9 the rest of the world is also in a debt crisis.

Defenses

Treasury bonds will not provide the safety that they have historically offered because they’re at the heart of the problem: financing the debt.  A well-diversified portfolio of inflation-protected assets will help, like Treasury Inflation Protected Securities (TIPS), commodities, and real estate.

Conclusion

There’s plenty to keep us all awake at night, but that’s a good thing. We need to be prepared for the worst, and grateful for the best.

Please Watch These Videos

We end each chapter with links to videos on the topic. The videos for this Chapter can be viewed here:

- Crashes with Inflation : https://www.youtube.com/watch?v=VH9ET-qyy5k

- Unconventional Thinking : https://www.youtube.com/watch?v=hzzpCfVkY7U

Chapter 12: Annuities and Other Risk Mitigators

- The main investment objective of baby boomers should be to protect their lifetime savings.

- Annuities are a good combination of investment and insurance, but locking in an investment at current low interest rates is undesirable

- Insurance companies and some non-insurance companies provide approaches that mitigate risk, as alternatives to annuities.

The central message of this book is that baby boomers should be protecting their savings at this critical time in their lives, as they transition through the Risk Zone. Readers can heed our advice by holding a portfolio of protective assets or they can hire someone to provide an assured income stream in retirement, just as defined benefit pension plans deliver. In other words, baby boomers can pay someone to take over the risk, to guarantee against losses, which is the role of an insurance company. But non-insurance companies also provide risk mitigation. In this chapter we discuss annuities and other risk mitigation choices.

In the 1980s, a protection approach called “Portfolio Insurance” became immensely popular, with tens of $billions invested. The idea is straightforward. We insure our cars and our homes, so why not our investments.  This idea fell into disrepute in October 1987 when it caused a market crash. The implementation of Portfolio Insurance was to synthesize a put option. The problem in 1987 was that too many people were trying to sell at the same time in order to execute the replication. By contrast, those who actually owned put options did not lose money; they profited from the crash. The moral of this story is that real Portfolio Insurance can be purchased, and it is easy – just buy put options. Most people are afraid of options because they don’t understand them, so the remainder of this chapter is about handing over assets to others who will generally use options and other techniques to limit their risks, and yours.

Annuities

Annuities come in three forms: fixed, indexed and variable. A fixed annuity pays the promised amount over time; it is the benefit in a defined benefit pension plan. An indexed annuity makes variable payments based on the performance of a securities index. And a variable annuity’s payments are based on the performance of the insurance company’s assets. The following discussion is primarily about fixed annuities. Annuities are provided by companies that sponsor defined benefit pension plans and by insurance companies. Many pension plans hire insurance companies to make their annuity payments.

The common question about annuities is whether they are investments or insurance. They’re both. As an investment, annuities actually tend to pay more than a safe investment in high quality corporate bonds, as shown in the following:

As you can see, policies for males (in green) pay more than those for females (in pink) because males have a shorter life expectancy.  The rates for males have always been above the return on AAA corporate bonds, while the rates for females have been roughly equal to the AAA rate. Insurance companies can pay more because they earn a “mortality credit” for pooling a lot of people together in a single policy – some will live long lives, and some will not. The problem recently has been that interest rates are artificially low under the Fed’s Zero Interest Rate Policy (ZIRP), so most people do  not want to lock in their savings at this time. There’s a good chance that annuity purchases will perk up when interest rates increase

As insurance, annuities serve the beneficial purpose of diversifying mortality risk. They are similar to the tontines discussed below.

Low interest rates create challenges for insurance companies too, namely it’s hard to make a profit. As a result, private equity companies are buying annuity contracts from insurance companies who want them off their books. These private equity firms are increasing profits by employing a strategy that Kerry Pechter, publisher of the Retirement Income Journal, calls the “Bermuda Triangle” for reasons shown in the following:

Private equity companies employ a two-pronged approach: operating efficiencies are gained by the triangle shown above, and investment returns are increased by taking more risk, investing in Collateralized Loan Obligations (CLOs) and Commercial Real-Estate-Backed Securities (CMBS). The “Triangle” works as follows:

- The private equity company manages the assets and creates a

- Insurance subsidiary that manages the insurance contracts and a

- Bermuda reinsurance company operates off-shore with less stringent requirements

Consequently, if you own an annuity, it would be good to know who is insuring your payouts currently.

The rest of this chapter discusses risk mitigation that is provided by both insurance companies as well as non-insurance.

Guarantees Against Loss

Insurance companies provide “Guaranteed Investment Contracts” or GICs that compete with Treasury bills by providing income while guaranteeing that market value will not decline.

Non-insurance companies compete with what is called “Stable Value” that uses  complex accounting and “wrappers” to maintain  constant value.

These are generally available only to institutions like pension plans and 401(k) plans. In order to compete with Treasury bills they need to deliver higher returns that are sought by taking a little more risk.

Structured Products

Creative uses of derivatives like options and futures are used to create attractive payoffs.  A Guaranteed Equity Management (GEM) is an example that promises 120% of the return on the S&P500 or your money back if the S&P declines in value.

Most structured products only work when interest rates are reasonably high, so there aren’t many in the low interest environment of 2021.

Guaranteed Minimum Withdrawal Benefit (GMWB)

Insurance companies sell riders to their variable annuities that allow the annuitant to withdraw a minimum amount each year even if it exceeds the normal variable payout.

Non-insurance companies financially engineer a similar  structure that can be viewed as a promised payout with an occasional bonus when assets perform well.

Defined Outcome Exchange Traded Funds (ETFs)

“Innovator ETFs” have entered the field of “shape shifting” return payoffs by using options. The following  example places “guardrails” around annual return. The investor  loses nothing if the S&P declines as much as the indicated “Starting buffer” but  participates in losses below that amount. Part of the cost of the protection is a limited upside, specified as “Average upside cap.” The actual upside participation is unknown before the fact.

Other variants include amplified ETFs that capture multiples of the upside and downside.

Tontines

Italian banker Lorenzo de Tonti created the first tontine in 1670, and it went on to become extremely popular among the rich in France in the 1700s and 1800s.  Banks sponsored a “club” of investors who pooled their investments. As contributors died, their share of the assets and the income was credited to the survivors, with the last survivor taking all. That way, participants were guaranteed an income stream for life, solving the longevity challenge, and those who died didn’t care.

Formal tontines are unpopular today, but the structure lives on with people  who move in together, like the TV series the Golden Girls, with the intention of lifetime support. Continuing Care Retirement Communities (CCRCs) are another example of a tontine-like structure.  CCRCs bring residents from independent housing to on-site hospitalized nursing care to death all paid by the community.

Pockets of Money

For those who have more than they’ll spend in their lifetime, it is good to know that your money will do everything you want it to do. This approach starts with a forecast of what you want to spend and when you want to spend it. Then zero coupon Treasury Inflation-Protected Securities  (TIPS) are purchased that will mature to satisfy each future payment.  Whatever is left over can be reserved for future adjustments and whatever else you like.  This is asset-liability matching, a technique sometimes used in defined benefit pension plans.

Target Retirement Income Plus (TRIP)

Another application of financial engineering generates a promised payment stream, like an annuity, but without locking in the contributed assets. It’s like pockets of money where each pocket is the same dollar amount. One unit of a TRIP provides one dollar of future payments per year for 20 years plus a kicker at the end of 20 years to create a sort of deferred annuity. The cost of a TRIP unit varies with the level of interest rates, becoming less expensive when interest rates rise. A unit cost $17 when 10-year Treasuries yielded 1.5%.

Please Watch This Video

We end each chapter with a link to a video on the topic. The video for this Chapter was recorded with guest John O’Brien, Adjunct Professor at UCLA. It can be viewed here https://www.youtube.com/watch?v=CNlQU1T24bw

Chapter 13: Living to 100 on Savings, Social Security and Medicare/Medicaid

- Longevity is on the rise, with current newborns expected to live more than 100 years

- 55 million baby boomers are poor and need help to live in their retirements. They are the “Retirement Crisis.”

- The other 23 million baby boomers have collectively saved $50 trillion. Most can afford a comfortable retirement

Rising longevity is a major financial issue because late in life there’s an 80% chance that one or both spouses could be in assisted living, skilled nursing, or memory care for years. According to Investing in (and for) Our Future  published by the World Economic Forum, the average retiree in the US will outlive their savings in less than 10 years, and it’s worse in other countries, especially Japan,

Demographers predict that children born since 2000 will live to 100, and children born in 2007 will live to be 104. For men, 68 today is the new 59.

How will baby boomers pay for many years of retirement

The retirement savings gap is global, representing a $70 trillion time bomb. The average retiree can expect to rely on social welfare and Social Security for most of their retirement years, but if it weren’t for the risk of getting seriously ill, many of us could be confident that our money would serve us for a lifetime even if we live to be 100.

The base case

We start with an estimate of what it costs for just the basics in America. 9 Retirement Expenses Every Senior Should Plan For reports that average expenses in retirement are currently about $42,000 per year, excluding one big unknowable – long term care.

The average baby boomer has saved $152,000 according to the 19th Annual Retirement Survey of Workers conducted by the TransAmerica Center for Retirement Studies. The average Social Security benefit is $1,503 per month in 2020, substantially less than the average wage, which is approximately $3,668, according to the Bureau of Labor Statistics. Subtracting $18,000 in annual Social Security payments ($1503 X 12) from the $42,000 average expense leaves $24,000 per year that will need to be paid from savings.

For simplification purposes, we’ll omit earnings on savings, and calculate how many years savings of $152,000 will last if you spend $24,000 per year for basic needs:

$152,000 savings / $24,000 spending per year  =  6.3 years

Savings will last just 6 years for the average boomer living an average life.

What boomers need

But averages don’t tell us that much. Let’s take a closer look at boomer wealth. Some are dirt poor, while others are mansion rich. All want to be psychologically healthy, as summarized in the following Maslow’s Hierarchy of needs:

Money goes a long way toward fulfilling these needs, but that does not mean they cannot be met by poor people. They’re just more challenging for the poor. In the following, we discuss how people in three boomer wealth groups will be dealing with retirement and psychological health.

What boomers have

Hundreds of articles have been written about the current “Retirement Crisis.” People have not saved enough. That’s true for most baby boomers, but not all, as shown in the following table from DQYDJ.

Here’s how to read the table. Starting at the top, 10% of boomers, which is 7.8 million people, have negative net worth below $962. They owe at least $962 more than they’ve saved. The next group of 7.9 million boomers, at the 20th percentile, have a net worth below $4,798. Continuing down the table, we’ve estimated that $300,000 is the very barest minimum a retiree needs for retirement, so 70% of baby boomers who have saved less than $279,594 will have a tough time paying for their retirements. They are the ”Retirement Crisis.”

Accordingly, we define the “Poor” as the  70% of boomers with less than $300,000 in savings.  In the following we discuss how these “Poor” baby boomers will live in retirement.   There are 55 million Poor baby boomers by this definition with a  collective net wealth of $5.5 trillion.

Next, we define “Middle” as the 25% of boomers with a net worth between $2 million and $300,000 in savings. There are 20 million Middle boomers with a collective net worth of  $20 trillion. If you’d like to know how these folks got to where they are, please download our free eBook How to Invest and Retire Like a Millionaire.

We define “Rich” as the top 5% of boomers with more than $2 million in savings. There are 3 million Rich boomers with a collective net worth of $30 trillion.

In the following, we discuss how each of these groups will live in retirement.

Poor Boomers

Our 55 million Poor boomers will need to find a way to live very frugally and to get the most out of welfare programs, Social Security and Medicare / Medicaid. These folks are living entirely off of their Social Security checks day-to-day, relying on Medicare Advantage plans for their routine health care, and they will need Medicaid if they become seriously ill. It’s not pretty, but it is real. But Poor people can achieve Maslow’s hierarchy for happiness with a reasonable budget. Happiness is more than money.

Housing is the most expensive need, averaging $16,000 per year for the average boomer, or $1300 month, which is just $200 less than the average $1500 Social Security check. A Poor boomer would try to spend about half that average, or $650/month, leaving  $850 for other living expenses, which is about one third of the $2100/month that the average retiree spends on non-housing. Keep in mind that the $850 residual also has to pay for utilities like gas and electric.

Maintaining housing costs below $650/month means you are limited to just a few cities and/or you’ll need to find a roommate or two. You would also try to find subsidized low-income housing,  but these properties are in great demand, so you’ll go on a waiting list  and need to figure out what do in the meantime. Here are some examples of cities with low rentals

- Wichita, Kansas: $470

- Cleveland, Ohio: $525

- Detroit, Michigan: $550

- Tucson, Arizona: $559.50

- El Paso, Texas: $599.50

- Oklahoma City, Oklahoma: $650

These are not terrible places to live by any means, but they could take you away from family and friends.

Healthcare could easily become the biggest expense that the Poor boomer needs to deal with. Medicare Advantage plans cover most of the routine medical expenses a boomer might incur, but the subscriber has substantial co-pays. If the boomer requires long term care Medicare only pays for skilled and rehabilitative care after a three-day hospital stay; this excludes custodial care, the assistance someone needs for daily living. The Poor can claim Medicaid benefits if assets are less than $126,420, excluding your home, and you earn less than $56,000 per year. Coverage and eligibility requirements vary by state. Medicaid recipients assign most of their Social Security check to the nursing home providing the care.

The fragility of Social Security and Medicare is a serious concern for Poor boomers. Medicare is forecast to run out of money in 2026 and Social Security in 2029 (it was 2034 prior to Covid-19).  Something will be done, and the sooner the better. There’s a good chance that human decency will spare the Poor boomers at the expense of wealthier people and younger generations.

The recent Covid-19 relief checks issued to Poor boomers are especially important to them, providing a little breathing room in a usually tense situation. Poor boomers are also likely to continue to work as long as they can, although opportunities become increasingly limited with age.

Will society continue to care for its 55 million Poor boomers? Can it afford to continue?

Middle Boomers

Life is easier for our 20 million boomers who have saved between $300,000 and $2 million, but they are also most vulnerable to events that could move them into the Poor group, especially investment losses. Using the same logic as applied for Poor boomers, the average Middle boomer can afford $2800 per month for housing, leaving $4700/month for other expenses. For reference, nation-wide rental fees average $1000/month, but some cities are much higher; average rents in Los Angeles are $2500/month and they’re $3500/month in New York.

For most of these boomers, savings are as high as they will ever be because paychecks have stopped, and spending has begun. Losses now mean less spending later, so lifestyles suffer, and you could run out of money.  Middle boomers are in the “Risk Zone” spanning the 5-10 years before and after retirement during which investment losses change the rest of your life even if markets recover. Your main investment objective at this critical time should be to protect your savings.

The average Middle boomer with a $1 million net worth should be able to afford the basics, and some extravagances, but needs to be prepared for the big wild card – long term care.  47% of men over 65 and 58% of women will need long-term care during their lifetimes, and the costs could be astronomical. There’s a 78% probability that at least one spouse will require long term care. On average men will need 1.5 years of long-term care and women will need 2.5 years but many find themselves in long term care for a decade or more. End of life medical care costs can bankrupt retirees. Dementia patients can expect to pay at least $300,000.

Medicaid is not an option for most Middle boomers. Your only options are to take your chances (self-insure) or buy long term care insurance. The average long-term care insurance annual premium is $3,490, so if you end up paying that over the course of 25 years it's a whopping $87,250. However, that sort of premium might buy you over $666,000 in coverage, according to the Long-Term Care Insurance Price Index. Should I Buy Long Term Care Insurance is a good guide for making this complicated important decision.

Like the Poor boomers, Middle boomers should be concerned about the viability of Social Security and Medicare because the benefits might be reduced.

Rich Boomers

You would think that this group of 3 million boomers with savings above $2 million would have no cares but you would be wrong. Rich boomers are accustomed to their nice lifestyles and want to leave some of their wealth to their kids and grandkids. Three things can spoil their joy: serious investment losses, high inflation, and critical illness. These boomers can take good physical care of themselves to ward off and treat critical illness. They can also take good care of their savings by protecting them from losses, especially in the Risk Zone, and by insulating savings against inflation.

One of the many fixes to Social Security and Medicare is a needs test that many Rich boomers might not pass, but this will not matter much to them.

Retirement Spending Budgets

The following graph summarizes the preceding budgets:

Poor baby boomers can live reasonably well but they will rely heavily on Social Security and Medicare/Medicaid. In many countries they would be considered wealthy. The biggest concern for Middle boomers is long term care because most will require it. Rich boomers need to focus on staying rich.

Will Social Security and Medicare survive

The Office of Management and Budget (OMB) routinely reports that Social Security and Medicare are running out of money, as summarized in the following table.

For perspective, the official national debt is around $23 trillion. Social Security and Medicare are “off balance sheet debts.” There are remedies to these bankruptcies, but the longer Congress waits, the harder it will be. Most believe that current recipients will be spared reductions in benefits. Nonetheless, baby boomers should be prepared.

Conclusion

There is a Retirement Crisis in the U.S. affecting 70% of our 78 million baby boomers. The good news is that these Poor boomers will probably make it through alright with help from their families and America’s social programs. All baby boomers need to protect themselves against illness,  investment losses and inflation. The greater the savings, the greater the threat.

In the next chapter we discuss getting the most out of Social Security and Medicare.

Please Watch These Videos

We end each chapter with links to videos on the topic. The videos for this Chapter are:

- How Will 78 Million Baby Boomers Pay for Their Retirements : https://www.youtube.com/watch?v=gzCrixwdx38

- An Interview on Our Real Debt :  https://www.youtube.com/watch?v=GPYtpC9_IcA

Chapter 14: Social Security and Medicare/Medicaid

- Social Security benefits can accumulate above $1 million

- Medicare is subsidized, reduced cost,  health insurance

- Medicaid is help for the needy

In the previous chapter on Living to 100 we report that most baby boomers rely on Social Security and Medicare to provide a reasonable standard of living, and we also report the costs to taxpayers of these awfully expensive programs that are forecasted to go bankrupt soon. In this chapter we discuss the choices that beneficiaries make and how to avoid mistakes.

Social Security

Background

The Social Security Act was signed into law by President Roosevelt on August 14, 1935. In addition to several provisions for general welfare, the new Act created a social insurance program designed to pay retired workers aged 65 or older a continuing income after retirement. The first one-time, lump-sum payments were made in January1937. Regular ongoing monthly benefits started in January 1940. Cost of Living Adjustments (COLAs) were first paid in 1975 as a result of a 1972 law. Prior to this, benefits were increased irregularly by special acts of Congress.

As reported in the previous chapter, Social Security has become increasingly expensive because people are living longer, as reported by the Social Security Administration:

Cost

Taxes were collected for the first time in January 1937. Social Security payroll taxes are collected under authority of the Federal Insurance Contributions Act (FICA). The payroll taxes are sometimes even called "FICA taxes." FICA is nothing more than the tax provisions of the Social Security Act, as they appear in the Internal Revenue Code. For 2021, the FICA tax rate for both employers and employees is 7.65% (6.2% for Social Security and 1.45% for Medicare). For 2021, the Social Security tax rate is 6.2% each for the employer and employee (12.4% total) on the first $142,800 of employee wages. There is no salary limit on the 1.45% Medicare tax. These taxes are paid while you are earning (accruing) benefits.

You might also pay taxes on your benefits if you earn additional income:

As reported in the previous chapter, these taxes are insufficient to pay current benefits, so the shortfall adds to the spending deficit. As people retire, the reliance on those who remain working increases.

Choices

Your main choice is when to claim benefits. This is an important choice that you should research and use available consulting services. You can claim early reduced befits at age 62, full benefits at age 67 or delayed (increased) benefits at age 70. Most Social Security advisors recommend that you wait as long as you can in order to earn the maximum benefit as shown in the following graph

General decision guidelines are as follows:

- Early (age 62) if you really need the money, don’t expect to live long or fear that Social Security will end

- Full (age 67 at this time) if you expect to live a normal length life

- Late (age 70) if you don’t need the money at age 67 and you expect to live a long life

The Social Security Administration provides information to help you make this decision, like the following sample benefit report:

Survivor benefits are an important aspect of your decision that is complicated so you should seek professional guidance.  Sometimes you can amend your decisions, but it’s best to get it right the first time.

Medicare/Medicaid

Background

On July 30, 1965, President Lyndon B. Johnson signed into law legislation that established the Medicare and Medicaid programs.  There are four parts to Medicare coverage as follows:

Medicaid provides health coverage to millions of Americans, including eligible low-income adults, children, pregnant women, elderly adults and people with disabilities. Medicaid is administered by states, according to federal requirements. The program is funded jointly by states and the federal government.

Costs

As discussed above, FICA taxes currently at 1.45% pay some Medicare/Medicaid expenses. Most people don't pay a Part A premium because they paid Medicare taxes while working. If you don't get premium-free Part A, you pay up to $471 each month. Most people pay the standard Part B premium amount ($148.50 in 2021). Those with high adjusted gross incomes pay more. Deductibles and co-insurance for Part B are shown in the following table. The costs of parts C and D vary as explained in the next section.

Choices

Medicare Parts A and B provide basic coverage that is insufficient for most people who get sick. There are two basic ways for recipients to fill most of the coverage gaps and reduce the risk of tremendous bills in a bad health year:

1. Medicare plus Medigap supplemental insurance policies

2. Medicare Advantage Plans

Most recipients purchase additional Medigap insurance that comes with a whole range of coverages and costs. Websites help you search for a plan that matches your needs and budget, but we recommend that you use an insurance specialist. In addition to covering the gaps in “Original Medicare” supplemental plans typically provide dental and eye care benefits. You can also choose a separate provider for Part D prescription coverage, or you can purchase it from your Medigap provider. The choice here is coverage and cost. You’ll want to see what it will cost you for your prescriptions; “formularies” can vary widely across providers.

Many cannot afford Medigap supplemental insurance, so a Medicare Advantage Plan, also called Part C, is a good choice. Many Advantage plans are free or low cost and include prescriptions. Most Medicare Advantage plans operate as a health maintenance organization (HMO) or preferred provider organization (PPO) insurance. HMOs limit members to using the doctors and hospitals in their networks. PPOs generally let members get care outside the plan's network, but members may have to pay more for such care. Some plans require prior authorization for specialist care or procedures, or a referral from a primary care doctor. Plans might not cover care given outside of the network’s geographical area. Extra benefits not covered by regular Medicare, such as eyeglasses, routine dental care, or gym memberships, may be offered.

Medicaid

Medicaid is discussed in the previous chapter. It can be extremely helpful to the poor. The main cost is assigning your Social Security benefits to the care facility that accepts you.

Conclusion

Important generous programs have been created for older people.  Ultimate benefits are directly tied to decisions made by recipients, so choose wisely and get help.

Please Watch These Videos

We end each chapter with links to videos on the topic. The videos for this Chapter are:

- Social Security  :  https://www.youtube.com/watch?v=Zi5PIj_1RO8

- Medicare   https://www.youtube.com/watch?v=pejNr9wLZws

Chapter 15: Reverse Mortgages

- Reverse mortgages are one way to “spend” the equity in your home.

- You maintain ownership and can repay anytime, but must repay when you sell your home

- Costs are fairly high, but generally less than the practice of routinely refinancing  a conventional mortgage.

If you own a home for a long time, you’ll build up equity through principal payments and appreciation. This equity is an asset you can use as needed. You can spend the equity in your house in a variety of ways. The oldest and most common approach is to downsize by selling your home and buying something less expensive. Or you can sell without buying a new home, using the proceeds for rent and whatever else you want.

A newer, less common, approach is to borrow against that equity with a home equity loan called a HELOC, or home equity line of credit. If you use this approach, you’ll repay the loan each month, just like a regular mortgage. Many financial experts favor the next approach over this HELOC choice.

A reverse mortgage is a third approach called a HECM  --  home equity conversion mortgage – where the lender pays you and you agree to pay the lender back when you sell the house or move.   According to the National Reverse Mortgage Lenders Association, homeowners aged 62 and older held $7.14 trillion in home equity in the first quarter of 2019.

This chapter is about the third option -- reverse mortgages.

Eligibility

Homeowners aged 62 or older who have a substantial amount of equity (at least 50%) are eligible to receive funds as a lump sum, fixed monthly payment or line of credit. Unlike a forward mortgage—the type used to buy a home—a reverse mortgage doesn’t require the homeowner to make any loan payments.

A reverse mortgage allows you to keep living in your home as long as you keep up with property taxes, maintenance, and insurance and don’t need to move into a nursing home or assisted living facility for more than a year. Importantly, you continue to own your home. Some mistakenly believe that the lending bank owns the home.

Types of Reverse Mortgages

There are three types of reverse mortgages:

Home Equity Conversion Mortgages (HECMs) are federally-insured reverse mortgages backed by the U.S. Department of Housing and Urban Development. An HECM is likely to be more expensive than a traditional home loan because of mortgage insurance that protects all involved parties. It is the most widely used reverse mortgage because it carries no income limitations or medical requirements, and the loan can be used for any reason.

A Single-Purpose Reverse Mortgage is offered by state, local, and nonprofit agencies. It is the least expensive process option for a reverse mortgage loan. The state or local government, or nonprofit agency, specifies the reason for the reverse mortgage. Homeowners can use single-purpose reverse mortgage proceeds only to pay for a specific lender-approved item, such as necessary repairs to the home or property taxes.

A Proprietary Reverse Mortgage A proprietary reverse mortgage is used for a larger advance for a home appraised at a high value. For example, if your property is worth more than $822,375, the 2021 lending limit for federally backed HECMs, you may be eligible for a higher loan if you go the proprietary route.

In the following we discuss the most common reverse mortgage – the HECM

How much can you borrow

The amount you can borrow will be based on the youngest borrower’s age, the loan’s interest rate, and the lesser of your home’s appraised value or the FHA’s maximum claim amount, which is $822,375 as of Jan. 1, 2021.

You can’t borrow 100% of what your home is worth, or anywhere close to it, however. Part of your home equity must be used to pay the loan’s expenses, including mortgage insurance premiums and interest.

The amount you can actually borrow is based on what’s called the initial principal limit.  In January 2018, the average initial principal limit was $211,468 and the average maximum claim amount was $412,038. The average borrower’s initial principal limit is about 58% of the maximum claim amount. This limit is increased by credited interest through time.

Reverse mortgage proceeds are not taxable. While they might feel like income to the homeowner, the IRS considers the money to be a loan advance.

What does it cost

Up-front costs include: Origination fees (which cannot exceed $6,000 and are paid to the lender) Real estate closing costs (paid to third-parties) that can include an appraisal, title search, surveys, inspections, recording fees, mortgage taxes, credit checks and other fees. Origination fees compensate the lender for processing the loan. We estimate that total up-front costs range between $15,000 and $25,000.

You’ll also pay ongoing interest on borrowed amounts and mortgage insurance.  Since lenders can’t ask homeowners or their heirs to pay up if the loan balance grows larger than the home’s value, the insurance premiums provide a pool of funds that lenders can draw on, so they don’t lose money when this does happen. All borrowers pay 2% upfront mortgage insurance premium on the maximum claim amount or appraised value up to a maximum of 2% of $822, 375 and on-going mortgage insurance premium equal to .5% of the borrowed amount annually.

Only the lump-sum reverse mortgage, which gives you all the proceeds at once when your loan closes, has a fixed interest rate. The other payment options have adjustable interest rates, which makes sense, since you’re borrowing money over many years, not all at once, and interest rates are always changing monthly or annually depending on the contract. Variable-rate reverse mortgages are tied to the Constant Maturity Treasury rate (CMT) (older contracts used the London Interbank Offered Rate (LIBOR)).

In addition to one of the base rates, the lender adds a margin of one to three percentage points. So, if CMT is 2.5% and the lender’s margin is 2%, your reverse mortgage interest rate will be 4.5%. As of April 2021, lenders’ margins ranged from 1.75% to 3.215%.  Interest compounds over the life of the reverse mortgage, and your credit score does not affect your reverse mortgage rate or your ability to qualify. Most contracts specify a limit (cap) on the amount of interest that may be charged.

Buyer protection

In order to protect consumers, HUD requires the following:

• Prospective borrowers must receive counseling before applying for a reverse mortgage.

• Counseling is conducted by independent, third-party advocacy organizations and housing counseling agencies.

• Counselors are HUD-approved, exam-qualified professional housing counselors.

• Borrowers receive documentation to prepare for the session

Conclusion

Reverse mortgages are just one way to use the equity in your home. They may or may not be right for you, but they are worth considering.

Please Watch This Video

We end each chapter with a link to a video on the topic. The video for this Chapter can be viewed here: https://www.youtube.com/watch?v=SywshvixHp0

Chapter 16: Smart Spending

- You need a plan to guide your spending in retirement that will minimize taxes and make savings last

- Asset location minimizes taxes

- A spending budget makes savings last

Smart spending can help savings last longer. It integrates two components: asset location and budgeting

Asset location

Tax minimization is the objective of asset location. Most investors have a variety of accounts that can be separated into taxable and tax deferred, also called tax qualified. You can save a lot in taxes if you hold “high realization” assets in your qualified accounts. High realization assets are high turnover and other assets that generate high taxes. Assets with low taxes should be held in your taxable accounts.

The average investor owns more than 6 accounts like the following

It’s a good idea to consolidate these into single accounts: one taxable and one exempt. This simplifies management and spending.

Some of the spending from your exempt account is required as a Required Minimum Distribution (RMD).   You are required to take annual distributions from your traditional 401(k) and IRA after age 72 and include that withdrawal in taxable income. The penalty for skipping a required minimum distribution is 50% of the amount that should have been withdrawn from the account. You can view this requirement as a tax liability that can be minimized by withdrawing even more than the RMD when your taxable income is low. The object is to withdraw as much as you can without paying taxes or paying very low taxes.   For example, if you want to pay a 12% tax rate on your retirement account withdrawals, you can withdraw an amount that keeps your taxable income below $40,525 as an individual or $81,050 as part of a married couple in 2021. You also want to consider possible taxes on Social Security as described in Chapter 14.

A RMD is  calculated by dividing your account balance by an IRS estimate of your life expectancy.

You can avoid paying income tax on withdrawals from your IRA if you are willing to donate the money to charity. IRA owners aged 70 1/2 or older can transfer up to $100,000 per year ($200,000 for couples) directly from an IRA to an eligible charity without owing income tax on the transaction.

Whatever else you spend beyond your RMD is discretionary. You should have a budget for spending as described in the next section.

Budgeting

You’ll need a budget if you want savings to last a lifetime.  Spending rules can be helpful and come in two forms: fixed and dynamic. The 4% Withdrawal Rule is a fixed spending rule that stems from a 1994 study by financial planner William Bengen. After testing a variety of withdrawal rates using historical rates of return, Bengen found that 4% was the highest rate that held up over a period of at least 30 years. The 4% withdrawal rule spends 4% of savings in the first year, & then that dollar amount increases by inflation in each subsequent year. You could replace 4% with another percentage – less would make savings last longer, and more would decrease the life of savings

Dynamic spending rules are designed to change annual retirement distributions based on actual market performance and, in some cases, the inflation rate. In addition, they can provide what are known as “guardrails” to adjust annual withdrawals, either up or down, to prevent a retiree from over or underspending. .

For example, one dynamic spending rule is based on ARVA or Annually Recalculated Virtual Annuity”. ARVA effectively recalculates each year the income that you would get if you could buy a fairly priced level payment fixed term real annuity based on current: (1) real risk-free rates, (2) a conservative estimate of how long you’ll need the income, and (3) the available assets.

Another example of a dynamic spending rule is to apply the longevity factor in RMDs to all your assets.

Whichever spending approach you use, you can “tax optimize” by carefully selecting  sources, rebalancing and tax loss harvesting.

Please Watch This Video

We end each chapter with a link to a video on the topic. The video for this Chapter can be viewed here: Maximizing Retirement Income https://www.youtube.com/watch?v=ZAwugkP8KD8

Chapter 17: Working in Retirement

- You’ll need 2 resumes

- LinkedIn is the recommended platform

- Age has its benefits

Working or not working in retirement can impact your happiness. Happiness is the topic of the next chapter. Some retirees are very happy just relaxing in retirement while others need the stimulation and challenges of a job. And of course, some need the money. In this chapter we provide some guidance for finding a job.   It’s based on our interview with Al Smith, “The HIRED! Guy”, author of HIRED! Every Employment Method and HIRED! Paths to Employment in the Social Media Era. We encourage you to watch the video link provided at the end of this chapter.

Where to look

You can start looking for jobs in the help wanted sections of newspapers and job boards, but experts report that only 20% of job opportunities are posted. Most jobs are assigned to recruiters who seek out candidates, mostly on LinkedIn. Accordingly, you’ll want to either hire an advisor who has mastered job searches on LinkedIn, or you could try on your own following the guidance in this chapter.

Regardless of whether you use an adviser or do it yourself you’ll need a resume and you’ll want to tell recruiters on LinkedIn that you’re available for hire.

Two Resumes

You’ll need two resumes – one for humans and one for computers. Your objective is to have a face-to-face meeting with a human, but computers will screen your resume.

The content of both resumes is the same, but the formatting is different. The electronic version should not include certain elements and word processing functions like the following because a computer will not read them properly.

e-Resumes should not include

- Header & footer (function)

- Dividing lines

- Table/column feature

- Symbols

- Borders

- Text boxes

- Graphics

You can find guidance on the internet to help you write a resume.   An advisor will help as well and can be specific to your situation. The top of the resume should state the Job Title you are looking for with a clarifying sentence that contains 3-5 key words that can help a computer discover you.

Your LinkedIn Profile

Recruiters will search for job candidates by title and keywords. Click on the pencil in “Open to work” section of your profile and enter the appropriate choices. You can choose titles there, but not keywords. Then click on the pencil for “Providing Services” and enter your keywords

About Your Age

Ageism, or age discrimination, is real. Some jobs are meant for young people like professional sports. But many jobs require experience rather than youth. In the movie The Intern Robert DeNiro’s character says, “Experience never gets old.”

The Society for Human Resource Management reports that baby boomers provide the following advantages to employers:

- Experience

- Maturity and professionalism

- Strong work ethic

- Serve as mentors

- Reliability

With commitment and perseverance, you will find the right job for you. Good luck.

Please Watch This Video

We end each chapter with a link to a video on the topic. The video for this Chapter can be viewed here:  Get a Job : https://www.youtube.com/watch?v=zSsfJlTOJEE

Chapter 18: Happiness

- The main elements of happiness are health, wealth and purpose.

- Purpose and gratitude are states of mind. Only we can make ourselves happy.

- Certain thought processes promote a positive mental attitude. We describe them in this chapter.

We’d like to leave you with happy thoughts. The rest of this book is about investing and finances, which are important elements of happiness, but happiness is not all about money as we share in Chapter 13 with Maslow’s Hierarchy of Needs., shown on the right. Near the time of his death Maslow was in the process of amending his model to include a higher level of psychological development, even higher than self-actualization called "self-transcendence.“ Transcenders have a strong need to help others and find ways to give back to the community in some fashion.

In this chapter we share some ways that baby boomers can develop positive mindsets. After all, we all want to enjoy life and retirement.  This chapter is a compilation of interviews with the following authors. Please watch the links at the end of this chapter.

Many thanks to:

- Larry Siegel, Fewer, Richer, Greener

- George Jerjian, Spirit of Gratitude

- Mike Drak, Retirement Heaven or Hell

Elements of Happiness

In very broad terms, the three main elements of happiness are Health, Finance and Purpose. We use the word “Purpose” to cover a wide spectrum of psychological considerations, especially Gratitude. A definition of true wealth is being surrounded by family and friends, in control of our life, and being healthy enough to do whatever we want with our time. We get the freedom to do that through our financial independence. We explain in Chapter 13 that baby boomer Finances can cover basic needs in the USA and there is insurance for Health costs, although being sick will indeed spoil happiness.  Most other developed economies provide similar financial and health support.

Our focus in this chapter is on “Purpose”. Some will find that they need to work in order to have a purpose, but working is not a requirement. Many find a purpose that is not a job.

DARE to be Happy

DARE is an acronym for pursuing happiness:

Discover. We are extremely lucky to have been born when we were. Our parents and grandparents had it much harder than we do, and our children will have an even better life.

Assimilate information. There are plenty of reasons that we should be grateful.

Re-wire. Develop a “Spirit of Gratitude” by purposely programming our minds to recognize how good life is.

Expand. Dream. Be adventurous. Have fun

The idea of “manifestation” is related to DARE. According to the Internet, ”Spiritual Manifestation is the theory that through regular meditation and positive, constructive thought, you can make your dreams and desires become reality. Spiritual manifestation holds that if you really want something and truly believe it's possible, it will happen.”

The Principles of Purpose and Gratitude

Here are some of the principles for achieving happiness:

- Nurture strong relationships. The people we surround ourselves with have a profound effect on our health and happiness.

- Foster good health. Poor health is a natural consequence of old age, and an obvious cause of unhappiness. Exercise and a healthy diet foster good health.

- Reignite your sense of adventure. This is the “E” in DARE. Don’t be disappointed by the things you didn’t do. Create a bucket list and do it.

- Tap into your spirituality. Denis Waitley, motivational speaker and author, observes “Happiness cannot be reveled in, owned, earned or worn. It is the spiritual experience of living every minute with love, grace and gratitude.”

- Find your tribes. Join groups of people who are passionate about the same things you are. The camaraderie and support are fulfilling and gratifying.

- Make the most of your time. Your time above ground is limited. Use it wisely and refuse to waste it on things that don’t matter.

- Adopt the right attitude. This is the “R” in DARE. Studies have found that a positive mental attitude extends life, but even if it didn’t it certainly makes life more fun.

Conclusion

Happiness is a state of mind that interacts with health and finances, some of which can’t be controlled.  Baby boomers can condition themselves to “roll with the punches” and take the view that every crisis creates an opportunity.

Please Watch These Videos

We end each chapter with links to videos on the topic. The videos for this Chapter are:

- Larry Siegel : https://www.youtube.com/watch?v=vNnlHdwwcMc

- George Jerjian : https://www.youtube.com/watch?v=GHb5PY7OMJQ

- Mike Drak : https://www.youtube.com/watch?v=7DyEzthx8r4