You may have seen the television ads that pose the big question: “What’s your number?” The number refers to the balance you need in your investment account to live comfortably in retirement. If these ads make you wonder how you are doing, you are not alone.
A single specific number cannot answer all your financial questions. Still, financial feedback is very valuable.
Whether in school, on the job or at the gym, feedback is essential for meeting goals. It reinforces good habits and motivates behavior changes when they are needed. So, are you making appropriate progress toward your long-term goals, or do you need to make some changes?
There are many different ways to answer these questions. Let’s start with the most straightforward, but perhaps the least helpful.
A December 2012 Wall Street Journal article featured the following information about household net worth and household annual income defined by approximate cutoffs for top percentiles. For instance, if your household net worth is $1 million, you are in the top 10 percent nationwide.
|
Household Net Worth |
|
Household Annual Income |
|
$ 6,816,000 |
Top 1% |
$ 521,000 |
|
$ 1,864,000 |
Top 5% |
$ 209,000 |
|
$ 952,000 |
Top 10% |
$ 149,000 |
|
$ 416,000 |
Top 20% |
$ 108,000 |
Beyond the rankings
Rankings give us information, but not much insight. Wealth and income rankings do not take into account age, family size, spending habits, local cost-of-living and many other factors. One million dollars in rural Tennessee is a big nest egg. The same sum won’t last so long in Manhattan.
Further, rankings can only tell us how well we are keeping up with the Joneses, or millions of Joneses. Financial well-being is a far more personal issue. Really all that matters is where we are relative to our own goals.
Ultimately, we need our money to support our desired lifestyle until death, as well as allow us to help loved ones, support charitable causes and so on. Goals vary widely from household to household, making it impossible — and completely irrelevant — to evaluate progress in comparison to the neighbors. Some families can live happily ever with a $1 million investment portfolio. Other families might hope to give that much away every year.
The question to ask: Will my income and investments allow me to meet my goals?
For example, consider whether you can retire according to your plans, travel when you wish, have a vacation home, make a difference through philanthropy or fund college for your children or grandchildren.
One good way to help explore these areas is typically through Monte Carlo analysis, a powerful computer-based technique that runs thousands of simulations based on current assets, savings habits, long-term cash flow needs, life expectancy and the wide range of performance we may see in markets over time. The output of Monte Carlo analysis is a probability — such as that you have a 90 percent chance of meeting your goals. Based on the inputs, your number could be lower, or it could be higher. This feedback can help you judge your progress and identify needs to alter your spending or savings behaviors, or adjust your goals.
It’s personal
Simply earning a lot of money is no guarantee of long-term financial health. This comment can elicit skeptical looks from investors currently saving for retirement, but for so many people, it’s a reality.
Consider an investor who has a reliable cash flow from a pension and Social Security. With modest spending habits, she has everything she needs, so it is difficult to come up with a scenario where she would run out of money. With absolutely no financial worries, she has managed to achieve this lifestyle without having a million-dollar portfolio. Many retirees who are living comfortably today do so because of the way they approach both spending and saving.
We are all aware of stories about professional athletes and others in the public eye who manage to squander tens of millions of dollars through reckless spending and irresponsible investments. Spending and saving habits have a far greater impact on financial well-being than most people realize. We cannot control the stock market, but we can control our own spending and saving habits and we should.
“How am I doing?”
This is a great question to discuss with your investment advisor. The feedback will help you stay on track.
Copyright © 2013, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
The effects of the financial crisis are still with us. And many books have been written about it. Alan Blinder's new book "After the Music Stopped," which focuses on the why it happened, is the best I've read so far.
Blinder, who brings great credibility as both a Princeton University economist and a former Federal Reserve vice chairman begins his tale by showing how the following factors all contributed to creating the "perfect storm" that flattened the U.S. economy in 2008:
Blinder then turns his attention to the actions taken by both the government and the Federal Reserve. He shows how their actions prevented another Great Depression. And he does this all in clear English, so you don't need an economics degree to understand how the Fed's actions saved the day.
Blinder then shifts to his recommendations for reforming the system. He provides a look ahead, including a clear explanation of how the Fed can successfully unwind the explosive growth in its balance sheet, preventing the much feared inflation that many have been forecasting from actually occurring. He also explains that while the central bank has shot its big guns, it still has some ammunition it can use if it believes more actions are needed to stimulate the economy. For example, instead of buying a certain amount of bonds, the Fed could pledge to buy whatever amount of 10-year bonds is required to peg the yield to a certain level. And it can reduce the interest rate it pays on excess reserves the banks hold at the Fed, or even charge banks instead of paying them. That would hopefully induce banks to put the reserves to work (lend them to clients) instead of holding them.
Blinder also provides a quick look at the long-term deficit problem, including his thoughts on the way forward -- the prescriptions need to cure the patient.
Bill Clinton's blurb for the book does a good job of summing up it up: "If you want to understand every aspect of our economic crisis -- how we got into it, how we escaped a depression, why we haven't fully recovered and what we have to do now -- read this book."
Copyright © 2013, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
I was forwarded an article that American Funds published touting the superiority of its funds relative to index strategies. The piece contains statements like this: “Some investment managers, American Funds among them, have distinguished themselves with a proven track record of consistently outpacing broad market returns.” And other fabulous statements like this: “Obviously, some are playing at a higher level, and using the average to characterize an entire industry obscures the fact that there are investment managers that have consistently added value over a variety of market cycles, including American Funds.
First point: love the modesty. I found myself being reminded that this was a piece by American Funds roughly every eight words. Second, this piece is illustrative of the type of half-truth analysis that permeates the financial services industry. While it’s true that many of American’s U.S. equity-oriented funds have outperformed the S&P 500, in 2013, that statement is basically devoid of any analytical depth.
At the very, very, very least, to test the claim that a fund or fund complex is adding alpha, the returns need to be examined relative to Eugene Fama and Kenneth French’s three-factor model that adjusts for any tilts that a fund might have toward small-cap versus large-cap or value versus growth. If this analysis shows significant positive alpha, then you can debate whether a fund manager or fund company possesses skill. When you apply this analysis to American Funds’ U.S. equity funds, however, that’s not what you find.
I pulled monthly returns data from Bloomberg from January 1980 through August 2013 for the seven funds that American compared with the S&P 500 in its piece (not all the funds had data for the full period, so I worked with the most data that I had for each). Below are the results from running the funds through the three-factor model.
These results show that while alpha has been positive at a bit shy of four basis points per month, it wasn’t statistically significant for a single one of the seven funds. Further, the analysis shows that the vast majority of what is driving the risk and return of these funds is attributable to generic exposure to the equity market, a focus on large companies and a slight tilt toward value stocks rather than stock-picking skill.