Many times I am asked, “How much money do I need to retire”? This may be one of the most important questions anyone can ask an investment advisor. The usual answer found around the industry results in a very complicated and fuzzy description, filled with disclaimers, because it is one question most people have not spent any time figuring out.

There are some golden rules of thumb that people have used throughout the years such as: only spend the income generated from the portfolio, or you can safely spend 4% of the total value each year and most likely not run out of money in your lifetime. (I particularly like the “most likely” part.) The first rule has you finishing your life with your savings intact, but would you not have preferred to enjoy some of the savings as well as the income? The second can be risky because you are using a hard and fast rule, 4%, against a value that fluctuates, the market and cost of living.

While the answer to the golden question is not simple, it is not rocket science. There are just a few major, predictable factors that influence the decision and if you take them into consideration, a reasonable estimate can be made to satisfy the question. First, is how much do you wish to spend when you retire? The first idea that comes to mind is as much as possible, but that is not always an option. A realistic number can be obtained from examining several years of expenditures and then looking forward estimating future spending levels. This is usually an eye opening experience, and even though we have been managing our own personal budget for years, putting in on paper makes us reflect back on the time we obtained our first job, feeling rich, and then quickly realizing how much rent, car, gas, and food really cost. And, don’t forget the first item, taxes. At that point we became a realist in determining how much we needed to live.

The second item in the planning process is probably the most misunderstood part of the process. It is not only misunderstood by most of the population, but also by people in the investment industry that are supposed to be “retirement experts”. The question of how long do you plan on living, is sometimes confused with how long will you live. No one knows for sure how long they will live, but there are ways to estimate how much longer you may live once you have reached a certain age.

Most everyone is familiar with numbers produced by the National Vital Statistics Report commonly called average life expectancy. You may have seen some of the statistics such as the average age in 1900 being 49 years. By 1970, the average age had increased to 71 due to better medicine and diet for both infants and older adults; currently, the average age is near 76. You must keep in mind that the average age is impacted by deaths of infants as well as older adults. To demonstrate how such averages might be misleading, let us suppose there were only two people in the world and one died just after birth and the other lived to be 80. The average age would be 40. This number is meaningless to either person and worthless for retirement planning.

A more meaningful number would be how much longer you might expect to live once you have reached a certain age. For example, if you are determining how much you need to retire, it would be useful to take the age in which you plan to retire, let’s say, 65, and then answer the question of how long might I live if I reach this age? Life expectancy calculation is much different than the average age. Statistically, someone that reaches 65 has a life expectancy of 16 more years. This would be 81, which is much different than the average age of 76. Using the average someone might only plan on having enough income for another 11 years when the more likely outcome is another 16 years, or 5 more than planned. The last five years might be very uncomfortable.

Just as not using the average to plan for retirement, it is also not a good idea to restrict your planning to just using the average life expectancy value. What if you live beyond the average life expectancy? It would also be useful to know what is the likely hood of your living beyond the average and for how many years? No statistical office or government agency has published a specific number, or determined the spread around the average, but one can be estimated. Several people have examined the numbers and estimated the standard deviation is around 10 years. You can make your own estimate by examining the IRS life expectancy table known as RP2000.

Rather than recreating the estimate, we can use it as a good estimate. This value creates an interesting picture. Once you reach age 65, you have a 97% chance that you will live to reach an age between 71, (81 – 10 = 71) and 91, (81 + 10 = 91). Again, taking our original question regarding retirement at age 65, you would need an income replacement to last at least 6 years and possibly as long as 26 years.

This places new assumptions on the retirement planning process. Traditionally, planning involved using an average date and ignored the range of possible outcomes. The use of life expectancy provides a more realistic picture that also requires a bit more planning on the investment front.

In the next article, we will explore how the range of life expectancy impacts portfolio returns and some alternative planning strategies. Investments can be managed to reduce the concern of not having enough, but the time to manage these expectations is now.

I am continuously amazed how many people believe the world’s stock markets are driven by day-to-day announcements in the news. At first glance it is easy to think this is true. There are no less than 10 networks that are dedicated to providing us with 24/7/365, minute-by-minute news on a global basis and even late breaking news via the television, smart phone and radio. We can observe firsthand how commentators describe the latest stock market movements and then begin to provide in-depth analysis about the recent news release and corresponding rises or drops in stock prices. Did you ever wonder if the news was providing real reasons for the movements or were they just reporting a coincidental event?

 Most investments are made to provide increased value at some point in the future. Usually, this is measured in years and rarely made to provide a return for just the day.  I have rarely heard of many serious investors making a major decision based on news of the hour or minute. Common sense asks, if investments are made for the mid or long term, why would data reported on a daily basis move the market in any direction? It probably would not.

 If an investor believed that a group of economic indicators such as employment, housing, or manufacturing would point to an improvement in the economy, they would be making a prediction for the next several years, or at least the next year. Does it make sense that a large number of investors would instantly change their mind, today, at this hour, because one of the indicators was not moving in the correct direction or not moving as fast as expected? Probably not, unless a major change in the long term direction was solidly indicated.

 When the news commentators try to explain market movements, many times they are searching for a reason and not stepping back and asking what could have happened that would change an investors long term opinion? How many times have you listened to commentators announce that the economy was experiencing difficulties this week only to hear in the following week that the economy is on a growth path? Investing in this manner would be equal to trying to drive down the road using your rear view mirror. History is useful but, you want to know what is likely to happen in the future

 How and why do they do this? Rarely do you see a listener call and question a commentator about their change in position? No one is keeping a close track record. The reason why many create this quick changing and urgent commentary is because long term analysis is rather boring. Can you imagine how many listeners would tune in to hear the morning report that consisted of comments that the long term forecast of the past several months was still on track? It would take about 10 minutes. Now what do they do for the remaining 23 hours and 40 minutes? It would not be good for advertising revenues.

The next time you are tempted to change your investment objectives, holdings or asset allocation based on the up to the minute news, just step back and think if your view has changed for the long term? And, is it based on facts and not just the interpretation of events by someone that might not know themselves. It will save you a lot of sleepless nights wondering if you have made the right decision.

The other day I was asked if I would invest money into General Motors (GM) if they come through with their plan to offer common stock to the general public. I thought about this in light of the material changes that have taken place in the American stock market and GM’s history.

 First, never before have companies, or the government, been so willing to use bankruptcy and receivership, as solutions to fix corporate problems resulting in common stock value demise.  What once was thought to be a last resort, something to be avoided at all cost, is now just another tool to recover from mistakes management has made in either financial controls or executing risky market expansion plans. The common stock holder needs to place greater emphasis on the long term view of a company and management, before investing valuable funds. GM does not score well on this front.

 Second, companies need to allow management to look long term and make necessary changes, so that they can implement a well thought out plan.  We need to define long term. From a management perspective that would normally be 5 years, and in some cases, even 10 years, depending upon the magnitude of the change required.

 GM has been making changes quickly since the government had to take an ownership stake in the company. Just a few days ago, Mark Reuss, GM North American President, said it was,” extremely clear” that a new management structure was needed. He has created a structure where sales, marketing and service are under separate leadership. Interestingly, just 3 months ago it was clear for the Chairman, Edward Whitacre, Jr. to fire then CEO, Fritz Henderson for having implemented the same plan just months earlier.

 Mr. Henderson had restructured to make things more efficient and effective just 9 months prior, but was fired in December 2009 and the Chairman, now CEO, Mr. Whitacre promoted Susan Docherty to the newly created position of VP Sales, Service and Marketing. The change was made to bring more efficient and effective decision making to the new GM.

 It appears that the most efficient decisions that have been taking place at GM are the amount of time a senior manager has in implementing change. With the last person only having 2 months before receiving the axe, I wonder how desperate the next VP of anything will be in making changes? This type of indecision and insecurity in managerial positions breeds desperate high risk actions.

 Should you invest in the new GM? If you enjoy extremely high risk positions, you might wish to look at Pakistani venture capital before taking on a company that has shown a repeated pattern of machine gun rapid fire shots, before determining where they are aiming, or what they are trying to hit.  The next rescue of GM will probably wipe out the shareholders. I don’t want to be one of them.

This a topic that does not need to be complicated but, people who talk about it want to make it sound complicated for personal reasons that may include ego, purposeful misdirection, such as in politics, or a general lack of understanding themselves. Throughout history the discussion about subjects such as debt, inflation and currency have been confusing for the general public. This is unfortunate because they are very important to every citizen of every country. They are three of the most important factors in determining a nation’s financial well being. Not knowing more about them is equal to ignoring the importance of the interest rate on your credit card, or mortgage, or not caring how much money you have in a checking account to pay monthly bills. I don’t fault the individuals for not understanding how something like a strong dollar impacts almost every aspect of their lives; I fault the politicians. Why? Politicians are the elected representatives of our country and they are charged with the well being of the country and citizens. This responsibility does not restrict itself to simply providing citizens free services and assistance which appears to consume most of their time. It involves the well being of the country’s financial strength just as each individual is responsible for their own financial wellbeing.

Most of the confusion revolves around using catch phrases to make an emotional point without explaining the true factual meaning. How many times have you heard the expression, “We need a strong dollar in this country?” Well, that sounds good. Everyone should be strong. How can you argue against that? What if that strength ends up restricting growth? Let’s take the simple statement of strong dollar.

If the U.S. dollar is strong it means our currency is of higher value than the other countries. Keep in mind this does not necessarily win an award or a gold medal. However, it does mean that Americans can buy more of other countries products and services because the US$ is worth more than the other currency. We can order products on the web, enjoy foreign cars, travel abroad and enjoy beautiful hotels and dine in the better restaurants, even do some shopping for presents.  In reverse, that means the other countries cannot buy as much of American products because their currency is weaker.

Just as a simple example, let’s assume a fair and equal value is set at 1:1 there would be equal purchasing on both sides. But as the US$ increases in value, let’s say the ratio becomes 1:0.5. Now the American can buy twice as much as the foreigner. But, in return the foreigner can only buy ½ as much of American products. A trade imbalance results and America ends up with a trade deficit because more products are coming in the country than we are shipping out. Americans end up producing less. Not necessarily because the other country is doing something evil or unfair, it can be because the dollar is strong.

Now think about the political rhetoric you have heard in the past? How many times have you heard we need a strong dollar along with we need to stop American jobs from going overseas? Why don’t we hear about a balanced currency where economic growth is in line with the currency value? It is more difficult to discuss and manage. Let’s face it; no one rallied a crowd by encouraging balanced global growth through fair currency practices.

When money is invested people expect to pay some sort of fee. It may be a management fee or a transaction fee or even a regulatory fee such as those that go to the Securities & Exchange Commission. No one really expects to conduct trades and be part of this activity without paying something. What people think they pay and the amount they actually pay are many times not the same.

This should be surprising because the investment industry is one of the most regulated activities in America. Now, we are not talking about the scams such as those concocted by the likes of Bernie Madoff. Those are clear and simple illusions. What we are talking about here are the fees that most people pay as part of the investment process but, they are unaware that the fee is even part of their investment.

Let us first look at the normal fees that people pay when they invest their money. We will divide the discussion on fees into several levels.
1. Level One – directly paid to a manager for conducting decision making on behalf of the client.
2. Level Two – transaction based charges that are a direct result of the activity of the investment decision making.
3. Level Three – administrative or regulator charges that are incurred and paid indirectly through additional itemized charges or as part of the investment that may get calculated in the cost of the trade or absorbed in a spread.
4. Level Four – incentive type payments that are made by any of the enterprises that are involved in the transaction.

Almost everyone is aware of Level One fees. These have been described as management fees or activity fees. A management fee is generally determined as a percentage of the total amount of assets in the account or value of the account. For example, if someone had $100,000 in an investment account and the manager charged 100 basis points (100 basis points = 1.00%), the annual fee would be $1,000. The fee is usually collected monthly so the client sees $83.33 collected each month from their account value. The philosophy is that the manager is incented to increase the value of the account through excellent investment decisions and thereby collects a higher fee since the fee is based on a percentage of the value of the account. The client and manager have similar beneficial interests.

A second type of Level One fee is charged to enter the investment opportunity, such as buying a mutual fund. These are referred to as up front loads, 12b-1 fees or marketing fees. These are disclosed to a client in a manner whereby they should be clearly aware that they are paying a percentage of the total value of the initial investment as an entry fee. Using the example from above, if the initial investment was $100,000 and the upfront load was 1%, you would pay the $1,000 in the beginning. All subsequent additions to the account and reinvestments of interest or dividends would also be charged the 1% entry fee. The philosophy with this approach is that you are rewarding the manager for making valuable recommendations.

Both types of Level One payments have their advocates. The biggest misconception is the entry fee activity is that the account is “free” unless trades are transacted. Sometimes the upfront load is not described clearly and the amount of the charge is also not declared clearly. Many upfront fees are in the 3% to 5% level. You need to be careful when the upfront charge is in excess of 2% because this is a significant amount of value deducted from the investment account in the beginning. In essence, the investor is immediately an extra 1% to 4% (upfront fee – management fee of 1% = disadvantage) behind from the start and this is compounded throughout the investment period of 10 or 20 years. That initial money never gets invested, at least not in the clients account.
Level Two fees are directly associated with the transactions themselves. This is different than the upfront loads we identified in Level One. The transaction fees we are focusing on at this level are items such as ticket charges and per share transaction charges. Each time you or your financial representative conducts a trade there is usually a ticket charge. This is the fee for processing the trade ticket in the system. It can range from a few dollars to maybe as high as $50 but, usually around $25. You need to know that each stock you trade creates a ticket. If you were to sell 100 shares of IBM and 100 shares of Exxon and 50 shares of Pfizer at the same time, you still would be creating three tickets.
Then there is a per share charge of a much smaller level which is usually between 5¢ to 10¢, depending on the complexity of the trade. Some international trades can reach $2.00 or more.

A Level Three fee is a regulatory fee or SEC fee which is so small it is rarely reported or mentioned on a statement but, usually is associated with the number of shares in the transaction.

Level Four fees are where it becomes more interesting. These have also been called “shelf space” fees. This is different than the upfront load or 12b-1 fee which is a marketing fee paid by the fund to the broker. The fee we are referring to in Level Four is usually disclosed in the Statement of Additional Information or Prospectus. Never heard of a Statement of Additional Information? Don’t feel bad; most people never have even seen one. This is where more details are disclosed about the funds that were generalized about in the marketing material.

There is a section in the disclosures where the fund tells about the fact they may pay investment advisors or brokers to recommend their products. It is usually titled, “Payments to Financial Intermediaries”. The payment is a direct distribution from the fund to the advisor or affiliate of the fund for placing the fund on the advisors “preferred list”. Some funds call this “revenue sharing”. Sometimes it is not just money but also includes “promotional incentives” that “could be significant and may cause a conflict of interest”.

When you evaluate an advisor or fund, make sure you understand all of the fees and how they are calculated. After all, it is your money.

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