The Impact of the “Boomer-ang” Phenomenon

As I write about often in my posts, the Baby-boom Generation are right in the midst of making the transition toward retirement.  As they do so, they must come to grips with the unique risks associated with this transition.  But a recent phenomenon is adding a new complexity to the boomers ability to plan for the retirement financial goal.  One of the realities in the era Post-Great Recession is that more adult children are expecting financial help from their parents.—in the form of a down-payment for a home, tuition payments, or in many cases a roof over their head.

There were some interesting statistics in a recent Harper's magazine article.  85% of this year's college graduates were planning to head back to live with parents for at least some time. Columbia University conducted a study in 2010 that showed 52.8% of 18- to 24-year-olds were living at home, up from 47.3% in 1970.  That means that it is now more common for this age group to be living with their parents.  Some of this can be attributed to the protracted unemployment we are facing on a national level.  Others are trying to super-charge their savings to attempt to get ahead in saving for a home.  Still others help parents in meeting monthly expenses.

The challenge (and danger) to the Boomers, is in the cases where a child living with them (or using funds ) is a significant drain on funds that were earmarked for use in retirement.  While some folks may have a goal to leave a financial legacy, this is not to be focused on at the expense of running out of money in retirement.  This creates a difficult psychological position for parents and is another side-effect of stutter-step recovery to the global financial crisis of 2008.

Be Prepared: Getting Ready to Get Ready for Retirement

If you think about it, you went to school for probably nearly a quarter of your life to prepare you for your career--a big investment of time and money.  But beyond just making sure we do not run out of money, it does not seem that we spend the same proportionate amount of time getting ready for the retirement phase of life.  With that in mind, I thought I would dedicate this week’s blog entry toward creating a checklist of items to prepare for transitioning to retirement.  Here are a few thoughts on getting ready to enter pre-retirement transition years: 

Debt: The 3 “No’s” of Preparing

•  Borrowing from Retirement Accounts—Accessing funds in an IRA comes with the sting of a 10% excise penalty tax, but many company plans allow you to borrow from them and “pay yourself back” over a specified time period.  Sometimes these loans come with record-keeping fees, and you could be missing out on potential appreciation on investment markets.

• Racking up Credit Card Debt—The interest paid to credit card companies is lost leverage in critical pre-retirement years.  Savings rate is quite important as you near pre-retirement years, and carrying balances on credit cards not only serves as impediment to saving, but also drains more money through interest costs.

• Accessing Equity in your Home—Home ownership is a critical key issue for the pre-retiree because your home will either serve as your retirement residence, or as a large piece of re-investable savings if you choose to sell and access built-in equity.  For those people carrying large loans into pre-retirement & early retirement, this key cash-flow item could force the need for more income sooner, or the need to downsize earlier.

Health:

• Not only is it no fun being in poor health in retirement, but it can also be costly.  While much of this may be out of our control due to genetics, having a healthy diet and engaging in reasonable exercise can boost general health. 

 Saving (Tax-Advantaged):

• Pre-Tax Savings Plans—For most of us, the pre-tax retirement savings plan(401k, IRA, etc.) will provide the best tax advantage; reducing taxable income now.  This is the primary place to engage in savings until you hit your limit.  Pre-retirees should aim to put as much in this bucket as their budget can bear because once earned income stops, so does their ability to use these plans.
• Roth IRA Saving—After you have max-funded your pre-tax savings and funded an emergency fund, funding a Roth IRA would allow those assets to compound tax free.  Some people may not be able to save in a Roth due to their income tax situation.
• Tax-Sensitive Savings—Saving in taxable accounts can be different to tax-deferred funds because of the requirement to pay capital gains and income tax “as you go”.  Being tax-sensitive with individual securities sometimes makes sense, as does funding cash value life insurance or annuities.  These choices are highly dependent on the goals set forth for these savings account

 Planning (not just financially):

• Just as having a vague idea about “what you wanted to do with your life” was a decent idea as you entered the working world, having some thoughts on what you want your retirement years to look like is also a good idea.  Whether it’s travel, taking up golf, or volunteering, this will give you some idea of lifestyle, which in turn gives you some idea of income needs.  Also, giving this some serious planning will help you to time your exit from the everyday workforce with what is right for you.

As I have written before, I believe that the retirement transition years are the most important in setting yourself up for the rest of your life.  It is important to be ready to start getting ready to transition.

Within the Volatility: Viewing the Positives?

Sometimes it’s hard to stay positive about the economy as you watch investment markets jerk downwards, upwards, and generally dance with volatility over a protracted period of time.  When almost every headline & television news show tells us that we are headed to recession (based largely on a leadership vacuum in world politics), I think it is important to also look at the economic underpinnings beneath the noise as well. 

A recent research report from Bank Credit Analyst Research – one of the world’s leading providers of global investment research since 1949 – listed a number of positive economic points that are worth noting when trying to determine the direction of the economy:

Oil prices have fallen sharply over the past four months. Oil is down nearly 25% from its high in late April of $113.93. This will provide relief to consumers and, combined with a bottoming in the market when we get there, will be a nice boost to potential economic growth. 

Real bond yields have fallen to extraordinari­ly low levels. Since many home­owners can therefore refinance to take advantage of better interest rates, consum­ers may begin to cash-flow relief.  

The Chinese economy continues to grow, and policymakers there have a lot of ammunition to deal with any slowing that may appear. Ear­lier this year, the fear was that the Chinese economy was trending dangerously, as policymakers at­tempted to give the people what they want in terms of economic growth to support China’s grow­ing middle class. Recent policy action in China suggests that policymakers there are moving away from a “growth at all cost” mentality to a more sustainable growth mentality. 

Treasury yields are low, indicating global confidence in the U.S. as a safe haven, despite the recent S&P “downgrade”. Now is a perfect time to have the political debate on spending and taxes. The difficulty is that, with the 2012 election cycle upon us, answers will probably not be coming forward from our lead­ers in Washington. We are on a low budget in the U.S., but that doesn’t mean that fiscal reform has to be a destroyer of our economy. Sensible spending restraint and some tax adjust­ments can allow the U.S. econo­my to expand at a healthy pace going forward.

Stock prices and interest rates are currently so low that we do not need economic growth to justify the purchase of equities. I do not think that the stellar prof­its many companies reported for the second quarter is a surprise to anyone by now. It is also en­couraging to note that earnings per share can still grow in a low economic growth environment. Firms will likely use the earnings that they do not pay out as divi­dends to repurchase shares since it is not likely that companies will continue to sit on ever-growing cash balances if they are not in­vesting for growth. It is likely this type of earnings growth will add support to the mar­kets. 

The index of leading economic indicators (LEI) rose for a third consecutive month in July. Admittedly, an advance in Au­gust will be a bit more difficult to achieve given the recent market volatility and negative sentiment. However, Fed accommodation still allows for a steep yield curve despite some recent flattening, which should provide some lift to August LEI. Unemployment claims holding in around the 400,000 mark may support LEI, and that level is not indicative of a reces­sion.

·        On Wednesday, August 24, dura­ble goods orders blew away ex­pectations.

o       A monthly surge in new orders for motor vehicles and parts – the best in eight years – headlined a strong durable goods report for July. Another economic measure that implies that the economy may not be what it appears--or at least may not be as bad as re­ported by the talking heads.

·        The Baltic Dry Index – the index measures the price of transport­ing raw materials by sea and is often cited by economists as a bellwether of global economic activity – most recent release revealed that it is now up 21 per­cent from its recent lows. Maybe those of us who think the global economy, while slowing, has not fundamentally changed are not misfits after all. While the index certainly has its critics, in an envi­ronment where investors are be­ginning to price in a global reces­sion, the increase in the Baltic Dry Index is one piece that calls that view into question.

      ·       Unemployment claims holding in around the 400,000 mark may support LEI, and that  

           level  is not indicative of a reces­sion. 

While there are certainly some fundamental issues that need to be addressed in the economy (particularly the level of government debt in Developed countries), not all news is bad news either. 

Revisiting the Efficiency of your Life Insurance Plan

A common issue upon which I revisit with clients on a regular basis is the efficiency of their life insurance.  Typically people will have either an old policy that was taken out when they first started their career and/or a specific amount provided by an employer.  While updating your coverage to a new policy can sometimes lower your costs with greater amounts of coverage because of the changing nature of insurance company mortality tables, often the original intention of the insurance has changed for the person.  For me, the question of reviewing their coverage always starts with the “Why?” question.  Why did you initially set up this coverage?

In my estimation, the main reasons for having life insurance protection in place are as follows:

• Income Replacement—purchasing enough coverage that would provide your heirs or dependents with enough money to replace the income you would have provided during your working years.  From a cost efficiency standpoint, this can often be accomplished through buying a term policy with a term that matches the number of working years remaining before retirement—with the idea that you are using the cost savings to fund retirement plans.

• Estate Tax Mitigation—purchasing permanent insurance coverage (sometimes via an irrevocable life insurance trust) to mitigate estate taxes that will be owed by your beneficiaries upon your passing.  While this type of plan should be orchestrated with an estate planning attorney, it can be helpful when estates are in excess of the government’s estate tax threshold (currently estates valued at $5MM).
• Tax-Favorable Savings Vehicle—For those people who are max funding retirement savings plans, Roth IRAs, personal savings, and emergency funds, a permanent life insurance policy could be a good way to grow cash value in tax-favorable way.  This typically is not a cost-viable plan until these other types of savings vehicles are being maximized.

I believe it is important to be careful with the overall cost of your life insurance plan.  Do not make the premium cost an impediment to other savings vehicles (especially tax-deferred savings potential).  When looking particularly at permanent life policies, be careful not to make it too large of a cash-flow item in the retirement budget.  It is always best to review your life insurance plan to be sure that it fits with the rest of the elements in your financial plan an overall wealth management.

Rollercoaster or Train Track?

I have sat down intently several times over the last 7 days to write an entry that addresses the volatility in the headlines.  First topic was the lack of impact that the debt ceiling deal had on markets.  Next was flight to US Treasuries despite the downgrade of US credit rating by S&P.  And then was the continued influence of the European banking problem that is potentially pouring over into US financial companies.

In the end I decided to shelve all of that to highlight the difference between simply investing versus investing with a plan backed up by infrastructure.  This kind of day to day volatility can definitely churn your stomach like a rollercoaster, as investment managers struggle to sift the data and find a support level in the investment markets.  However your exposure to the volatility should differ based upon your time horizon and overall appetite for risk.

The Phases of Investment Exposure

While the traditional savings paradigm is a simple save/accumulate to distribute illustration (seen to the right), I would argue for several phases along the way:

Distribute, Protect, & Grow—Having a plan for efficient and consistent distribution of assets is critical to meeting your expense needs; however more than likely you will still need some tilt for future growth because of the extended timeframe of retirement

1. Save & Grow--early in saving for a long term goal like retirement, where you may have the ultimate stomach for short-term volatility on a significant portion of your savings.
2. Save, Grow, &  Protect—As you start to amass a significant savings for your goal, beginning to build a protection infrastructure around your savings becomes important.  This may involve using different investment vehicles and alternative asset classes that are not correlated with traditional liquid investments.
3. Protect & Grow—At some point in the cycle, protection trumps growth as you get closer to needing to tap funds for retirement.
4. Distribute, Protect, & Grow—Having a plan for efficient and consistent distribution of assets is critical to meeting your expense needs; however more than likely you will still need some tilt for future growth because of the extended timeframe of retirement.
5. Distribute, Protect, & Transfer—While not the primary concern for retirement planning, efficient wealth transfer should be addressed once you have come through the danger zone of pre-retirement and early retirement years.  This may involve re-checking beneficiaries on retirement accounts, and tending to trust matters for after-tax assets.

Using All of the Asset Classes

When volatility spikes your exposure to alternative asset classes could prove to be a nice anchor for your savings.  While these investments require a suitable income and net worth because of their liquidity & risk profile, vehicles such as non-traded real estate investment trusts, equipment leasing partnerships, and business development companies could provide consistent income that is not correlated to the day to day volatility of investment markets.  For those that this type of planning is suitable for, I recommend that the alternative asset class sit right along with equities, bonds, and cash, and be between 5-20% of your allocation (dependent on which phase of retirement transition you are in).

Consistent Income

Lastly, the biggest worry about the fluctuations in your retirement account ultimately goes back to the accounts ability to produce income for you on a consistent basis in retirement—either through income generating investments or through liquidation of assets.  It is for this reason that you should revisit your income plan on a regular basis during pre-retirement and early retirement years.  This includes looking at Social Security projections, pension plan provisions (and the adjustment to your spouse’s income if something were to happen to you), and then looking at the efficient distribution of your savings so that it lasts through your entire retirement.

Just like a good business plan is written down, your retirement & financial plan should be codified somehow so that you can review it as necessary, but also so that when volatility re-enters investment markets (which it inevitably does) you can feel confident that you have an infrastructure in place to weather the dips.

Alternative investments are subject to significant risks and therefore, are not suitable for all investors. When considering alternative investments, you should consider various risks, including the fact that some products use leverage and other speculative investment practices that may increase the risk of investment loss, can be illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees and in many cases, the underlying investments are not transparent and are known only to the investment manager. With respect to alternative investments in general, you should be aware that returns from some alternative investments can be volatile and you may lose all or a portion of your investment. 

Between the Lines of the Debt Ceiling Agreement

The deal to cut more than $2 trillion in government spending over the next decade and extend the government's ability to borrow until at least 2013 has been signed, sealed, and delivered.  So what was all the fuss about?  And what was really gained by this polarized government brinksmanship?

The debt ceiling debt debate over the last few months achieved one unintended goal.  It surfaced a sleeper issue with the American public to raise the importance of our country’s out of control debt and unsustainable entitlement programs.  Politicians on both sides of the aisle have talked about addressing the problem for a long time, but this has forced the country to face this problem head-on.

The agreed upon bill will cut spending slightly in the early going; which is certainly better for the fragile state of the recovery. The spending cuts will begin with just $25 billion in 2012 and $46 billion in 2013.  This is the tightrope that legislators walked while attempting to form this bill, as economists weighed in that cutting any spending could reduce US GDP (a measure that is already quite low signaling potential sluggish economic growth).

While everyone seems to agree that government debt and spending are out of control, agreement on where to make significant enough cuts to actually impact debt remains unseen.  Major expenditures of Medicare and Social Security, as well as national security seem to be areas that the average American does not want disturbed, but these also remain major weights to the ballooning debt.  It may be clear that we need and want smaller government, but achieving that may be more painful than we want.

The next step in the debt debate will be the appointments made to the bi-partisan super-committee in Congress, and what potential plans can be agreed upon heading into a presidential election year.

The Context for the Debt Debate



History of the U.S. Debt Limit1

 
The last time Congress raised the debt ceiling was in February of 2010. At the time, it was increased by almost $2 trillion.
The fight in Congress over the debt ceiling and fears of a government shutdown are all over the airwaves, so I thought I would touch on a few aspects of the debate, and frame the context for the battle currently being waged in Washington.

History of the Debt Ceiling

The debt ceiling first came into existence in September of 1917. At the time, Congress authorized the issuance of $7.5 billion of bonds and another $4 billion of certificates of indebtedness under the Second Liberty Bond Act.

If we take that $11.5 billion dollars, adjust it for inflation from 1917 through 2011, outstanding debt would have increased to just over $193 billion dollars. The current debt limit exceeds $14 trillion. Washington’s “love affair” with debt has not only grown, it has grown exponentially since 1982.

Looking at the statistics of how US government debt has grown historically, I think it is important to look at two key points:

1. The debt ceiling did not hit the “magic” $1 trillion mark until 1982… less than 30 years ago.

2. Increases in the debt ceiling are quite common. Over this 94 year period since 1917, the debt ceiling was revised 102 times!

Also of interest, Congress has NEVER refused a President’s request to increase the debt ceiling, which is part of the current problem.

A second way to look at the debt ceiling is to look at it in relation to the nation’s Gross Domestic Product (“GDP”); or the market value of all final goods and services produced within a country in a given period. Looking at all available data on this comparison dating back to 1929, we can see that the all-time high for the debt limit to GDP occurred right after WW II when it exceeded 120 % of GDP. If Congress votes to increase the debt ceiling again this year, the debt limit could once again reach 100 percent of GDP. While the U.S. may not be fighting a world war this time around, it is borrowing money like it is.

Options for policy makers to bring debt levels down and cure its addiction to debt-related expenditures are to cut spending, raise taxes, or both.

Why Does the Debt Ceiling Exist?

In a nutshell, the debt ceiling is Congress’s way of setting a limit on how much the U.S. Treasury can borrow. Our Constitution presents Congress with the task of managing both spending and borrowing. When Congress’s appetite for spending exceeds available funds, the government borrows money via U.S. Treasury securities.

While the debt ceiling was proposed with good intentions, it has done little to stop our nation’s exponential rise in debt. More recently, it has become a source of political grandstanding, as policy makers attempt to “stand tall” against a debt problem of their own making.

How Could the U.S. Lose its Aaa/AAA Credit Rating?

According to the credit analysts at Standard and Poor’s, the rating agency would downgrade the quality of U.S. debt for the following reasons:

1. If Congress and the administration fail to come up with a “credible solution” to the U.S. debt and show no signs of agreeing on one in the foreseeable future.

2. If the United States misses any scheduled debt service payments, in which case S&P would issue a “selective default,” meaning a default has occurred on some bonds but not others.

3. If S&P concludes that the debt debate calls into question policy makers willingness and ability to timely honor the U.S. scheduled debt obligations.

How Does the Stalemate Get Addressed?

I think investors and Americans in general, would very much like to see a bold resolution to the current debt debate. In the end, though, a mini deal that satisfies neither side will probably get through and the debt ceiling will be increased. For the optimists, a grand bargain on spending, taxes, and debt will have to wait until after the next election.

From an investment standpoint, for the markets to retain their composure, they do not so much need a solution to the “crisis” as they need more certainty about the direction policy makers will take over the next few years. Stay tuned as the debt debate rages on.


Source 1: U.S. Treasury


Source 2: U.S. Treasury, Bureau of Economic Analysis


Source 3: Jason Geopfert - Sundial Capital Research, Inc.