Is There Such a Thing as Too Much Choice?...

A good friend of mine who was hosting a party asked my advice on selecting two entrée items and some hors d’oeuvres based on the catering company’s offerings. No problem, I like food. What I encountered was page upon page of great sounding options. I quickly marked the items to revisit but before I knew it there were dozens up for consideration.

Paralyzed and worried how the beef wellington tenderloin compared to the mesquite roasted beef sirloin with horseradish jus, I threw up my hands and asked co-workers for advice. Too hard to decide, too many choices.

Life is full of these overly complicated yet simple decisions. Take your 401k. Conceptually it’s nice your 401k provides such a variety of investment options, but many participants don’t select what’s right for them, resulting in poor decisions and anxiety.

It’s the responsibility of the employer to set up the 401k, but it is on the employee to decide how much is withheld from their paycheck and, furthermore, how those contributions should be invested.

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Ten percent should be your minimum objective, 15% would be really good. That’s the amount that should flow out of your paycheck into your 401k. In a 2018 report, the Stanford Center on Longevity determined that if you want to retire by age 65, you should be setting aside 10%-17% of your income. And that’s if you start saving as early as age 25. If you wait until 35 to start, plan on 15%-20%. People aren’t doing this, most notably younger workers, when saving has it’s greatest long-term impact.

You have funded your 401k, now what? A recent study found that the average 401k plan contained 27 different investment options, mostly mutual funds. What are the right ones to choose for your situation?

Some methods investors use are choosing funds with the best performance over the past year or selecting a fund because a neighbor recommended it, or worse yet, stay as cash, that seems safe and secure. Here’s a tip, do not do any of these.

401ks may offer a lot of variety, but you are restricted to using what’s on your plan’s list of investment options. Most 401ks will offer index type funds, typically they are Vanguard or Fidelity funds. These are low-cost index tracking funds that provide broad global exposure; if available in your plan, use them.

The stock portion should have a little more than half in a US index fund and the rest in an International index fund. For bonds, select a single index fund option that covers the US bond market. The reality is with 2-4 funds you will have excellent diversification at a very low cost, making the most of a restrictive and overly complex situation.

Another option is a “target date” fund. Here you find the year you wish to retire, then choose one of the target date funds that has a year closest to your retirement date. You do not need more than this. The fund will automatically adjust the stock to bond mix as you move toward retirement. You will pay more for this approach over the index funds, but most are within reason. But you still need to pay attention to your risk.

For instance many retirees in 2008 utilizing a target date fund thought the fund would have minimal stock exposure upon retiring. The ensuing financial meltdown left many surprised at the losses they incurred given half their wealth was still in stocks.

The real difficulty lies in keeping your emotions in check and ensuring you adjust appropriately as your goals evolve. This is particularly true the closer you get to retirement. People are unique and your personal situation may call for an entirely different allocation than what the standard formulas say.

There you have it. If you are using more than 5 funds in your 401k you are probably making your life too complicated.

The Reason We Save…

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Is because we have a certain level of confidence that the future is bright and to enjoy those positive prospects we must be prepared. But what happens when an entire generation starts feeling less optimistic about the future? Younger people around the globe are tending to favor spending now in place of more responsible saving habits of past generations.

This behavior is best exhibited in South Korea. A nation on edge, caught between capitalism and the ever-constant inconsistency of their neighbors to the north. The angst in this region has created a real psychological challenge, so bad that nearly half of all South Korean deaths for people in their 20s are due to suicide. Those that don’t succumb to this awful outcome are “stress-spending” to cope with current conditions.

One of the main reasons this is happening in South Korea is the current structure of business, which is dominated by a handful of family owned conglomerates like, Samsung, LG and Hyundai. Young entrepreneurs who don’t feel they have a shot at making it big are throwing hands in the air and saying, “Screw it, let’s go get some filet mignon!”.

South Korea isn’t alone with this behavior. The U.S. is ahead of the curve when compared to most emerging market countries, mostly because we got our “kick in the pants” during the 2008 financial crisis. Household debt when compared to disposable income had peaked at 135% in 2007 but has since dropped to 101% in 2018. China on the other hand is moving rapidly in the opposite direction where the same ratio has reached 117%, up from just 42% in 2008.

Today’s Chinese youth see money as a thing to be spent, starkly contradicting previous generations devotion to saving and commitment to supporting family members. What is further concerning is that young Chinese don’t really seem to care that they are on a poor retirement saving trajectory. But the real concern arises when the unavoidable rainy day happens, and the dominos start to tumble.

For instance, there will be a large impact felt in China if job growth slows. The job market has changed in China over the decades; 1978 saw just 165,000 people graduate from college. Compare that to 2019, when more than 8 million Chinese youth are expected to earn their degrees and hit the streets of Shanghai, Beijing and Hangzhou. When jobs are cut, millions will be left with debt they cannot pay.

Here in the U.S. we face a slightly evolved situation that finds today’s youth saddled with large amounts of college debt. Eric and I alternate semesters teaching a personal finance course at UVM to undergraduates and take a poll each semester. Last semester 62% of students polled expect to graduate with debt. Of those facing a life of debt after school, the average amount owed is $25,000 and 16% say they will be on the hook for over $50,000. This doesn’t include potential costs of medical school, law school or graduate school.

With total student debt exceeding $1 trillion dollars it’s no big surprise that younger workers spend their income differently. Home ownership is way down amongst young Americans, with over 40% claiming it will have to wait until debt can be paid off.

One pattern we are happy about is the adoption by companies to auto-enroll new employees into 401ks. We preach in our UVM course that students need to, at a minimum, put 10% of their income aside for retirement once they join the workforce. But studies show that many don’t get started until they are 5, 10 or even 15 years into their working careers. A study by Vanguard recently showed that the average percentage of income being contributed to 401ks, for all ages, has essentially been flat since 2004 at around 10%. The grim reality is that two-thirds of millennials have nothing saved for retirement, frightening!

A student earning $50,000 after graduation and putting away 6% of their paycheck into a 401k with a 4% employer match, could expect to have saved close to $2 million dollars by retirement. But if that person waits until they are in their early 30’s to start saving, they will have saved less than half what they could have if they started right after college.

As a parent to three young children, I pray that optimism for a bright financial future returns soon.

In Case You Haven’t Heard…

Our population is getting older and doing so at a quicker pace than was projected in the past. For the first time in U.S. history there are more people over the age of 65 than under the age of 5.

Here in Vermont this has led to a recent downgrade in our sterling AAA bond rating by Fitch to AA+, which pulls Vermont in line with the rest of the New England cohort. Fitch reasons that Vermont now has the third oldest population in the country leading to slower projected economic growth with more social programs and less tax dollars available for funding. Vermont is an old state and very well may be the canary in the coal mine for the rest of the globe.

The historical pattern for fertility has typically followed a roughly 100 year trajectory whereby newer countries peak at around six children per family and level out at the naturally sustainable fertility rate of around two children. This fertility evolution stretched about 88 years in the United States. But the pattern unfolded at a much quicker pace in places like China and South Korea, where moving from six to two happened in only 22 years (See illustration.) In fact, in South Korea things have now dropped below the 2.1 naturally sustainable population level, leading experts to predict total population in that country to be 30 million by the year 2100. That’s a whopping 40% decrease from current population of 51 million.

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But there are areas of the world population that still are growing quickly, mainly in Africa. Small farmers make up 70% of the Sub-Saharan African population and extra hands to help out are in high demand. One sure way to increase a workforce on these farms is through childbirth. As the saying goes, “children have two hands but only one mouth.” But even in these pockets of the world the downward trend in fertility is moving more quickly than was originally anticipated.

As countries mature opportunities for education and career alternatives lead to lower fertility and focus on less tangible things, like spending quality time with children. Raising a child is expensive which in turn drives fertility rates down. This is a First World problem.

We are also thinking differently as we move from generation to generation. 2019 will mark the first time that Millennials will outnumber Baby Boomers. Generally speaking Millennials are more socially liberal. Same sex marriage, interracial marriage and legalization of marijuana are all things Millennials see as the norm. They are also less focused on raising a large family and more interested in their careers, which at the moment are dominated by the tech industry.

So what does this all mean? The positive is hopefully these population changes will be good for the environment. But it also means we may need to start to think of things a bit differently. There are two main drivers to economic growth; population growth and productivity. If we aren’t having enough babies then the only other way to grow population and in turn the labor force is through immigration. Immigration broadens the talent pool for future innovations leading to greater productivity, propelling our economy forward.

So perhaps the investment opportunity lies in companies that focus on improving productivity and less on those companies producing products and services in the discretionary consumer sector, which relies more heavily on ever increasing populations. These products geared towards improving productivity include automation, robotics and technology.

The patterns clearly show a slowing in worldwide population growth and as previous generations have always shown economic adjustments will be made to account for the new reality. Who knows, we may be closer to the first robotic President than we think.

Best to Sit for This Ovation...

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The Chicago Symphony Orchestra recently concluded the longest labor strike in its prestigious 128 year history. The issue at the heart of the dispute was the future of the pension plan offered to musicians. While pensions have become quite scarce in the private sector, they remain a cornerstone among the nation’s leading orchestras. Earlier this month, behind closed doors of the Mayor’s office, a deal eliminated the pension plan for the orchestra.

This is not surprising. Only about 15% of Fortune 500 companies offer pensions today, down from nearly 60% of companies just 20 years ago! This enormous shift in retirement saving responsibility has people changing the way they approach their retirement.

The solution to accumulating enough money is an easy equation; save more money and do so over a long period of time. But once you have all this money, how do you go about spending it during retirement? The longstanding adage calls for retirees to pull no more than 4% of investment account values during retirement each year. For example, a $400,000 IRA should produce $16,000 of annual income come retirement. Investing in a balanced portfolio of stocks and bonds should help keep pace with your withdrawal and even help offset the pace of inflation.

The 4% Rule makes good sense, but assumes that retirement spending is a steady game. Thirty years of Bureau of Labor Statistics data show a pattern of retirement spending declining persistently over a retiree’s life. Another study by Morningstar shows that spending declines 1%/year for the first decade of retirement, 2%/year for second decade and about 1%/year thereafter. JP Morgan used proprietary data from actual bank accounts and credit cards to track spending habits for retirees and found the same: more spending early on with a consistent decrease over time (see graph below).

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We are living longer, thank goodness, but this means retirement can last upwards of three decades, if not longer. With such an extended time in retirement, it makes sense that spending will vary over time. These periods of retirement can be broken into three distinct phases; the “Go-Go” early years of retirement, the “Slow-Go” years and eventually, the “No-Go” years.

During the early “Go-Go” years spending will be higher on getting out and enjoying retirement. This phase is the most expensive of the three as travel, home improvements and eating out are more prevalent. But studies show that each year into retirement brings a slightly reduced level of this spending. As health and energy start to slow, less is spent on discretionary items. The “No-Go” phase sees discretionary spending replaced with higher health care expenses.

But life isn’t a reflection of a bunch of data points. Planning for reduced spending in nice tidy 10-year bands is a good exercise and planning technique, but spending changes often will be an unavoidable event, most likely triggered by a health-related experience.

This realization that spending during retirement is not a straight upward sloping line, but rather a series of decreasing spending years means many may be able to enjoy the early years of retirement more than was originally thought. But the responsibility is on the individual and not the employer to make the math work. This most certainly means saving more of each paycheck and/or preparing to retire later in life.

A long retirement is a wonderful thing that can be wildly rewarding albeit, for many, laced with financial challenges.  However, much like the Chicago Symphony Orchestra, the pensions are gone but the show must go on!