 |
Weekly Insight |
July
16, 2004
IN THIS ISSUE:
We begin a three part series on preparing for and enjoying retirement with a look at a planning process and a careful examination of investment strategies to maximize your account. Expect some surprises (oxymoron?).
Volatility is the Price for More MoneyThere is just one story this week. It's all about funding for a period in your life when you either do not want to or can't work for gain. Everyone starts from a different point in their lives, has a particular risk orientation and expects different levels of sustenance in "retirement". Each person's needs are different; we urge you to discuss particulars with us that we might help you with specific points on your way to having a comfortable living if and when you let go of gainful employment.
We look on retirement saving as an opportunity fund; with a certain amount of assets, you can live the kind of life you desire, irrespective of needing to work. You may, like millions, choose to work well into your 60's and 70's or even longer. That does not mean that a retirement plan is not for you. It simply means that you may need less. Note that life is not predictable. You may encounter a health issue which forces you on your savings sooner than you'd planned.
Jeremy Siegel in his book, Stocks for the Long Run, observed that stocks outperformed bonds in EVERY 30 year period since 1880. Furthermore, using the Ibbotson data, we find that stocks outperformed bonds by 100% over the period 1925-2002 - 10% average annual gain for stocks vs. 5% annual gain for bonds. In simple terms, this means that $100 invested in bonds in 1925 doubled every 14 years, while the same account in stocks doubled every 7 years. Let's just interpolate these results over 30 years. $100 invested in stocks grew to $2000 over the 30 years; $100 invested in bonds grew to $400. Such is the power of compounding.
Of course, not every 30-year period was exactly the same, but they almost always had at least one throw away decade and one decade of great performance. Still, the relationship holds. Someone who plans to hold an account for 30 years will have a much larger account, in ALL probability, if it is invested in stocks rather than in bonds. We will assert in the next installment that, even in retirement, the reward for holding stocks is far greater than for holding a portfolio 100% in bonds or CD's. If income is needed, however, it may be propitious to hold about 25% of an account in bonds or dividend paying things like Real Estate Investment Trusts.
But, you say, how can you sustain
a 50% loss and still make money over time? In fact, stocks did lose 50% and
more in the bear markets of the 30's, 1973-74 and 2000-2002. We can't say
much about stock performance after 2002, but we note that the 40's and 50's
were generally good times for stocks, as were the 80's and 90's.
The argument for stocks is cogent, but it leaves out an important behavioral
issue - sustaining a big hit is probably not psychologically acceptable. People
are more likely to panic and sell into the panic and never invest again. Everyone
is different. It takes nerves of steel to sustain a large loss, but that's
exactly what the probabilities dictate. The large loss creates the conditions
for the large gain, and vice versa. Fortunately, stocks gain in roughly 3
years out of 4. Here's the real rub.
Suppose the 50% haircut happens late in your investment program, when 50% is a very large amount? As bad as this sounds, it's still better than holding a portfolio of bonds - so long as you stay with he program. Simply put, volatility is simply the price for having more money - period.
You must be thinking that this writer is out of his gourd - how would someone in their right minds rely solely on probability for the important decision of how to build and manage retirement savings? Frankly, we don't have total faith in probability, either. We also recognize that working life may be cut short or any number of other things may happen to spoil the "perfect accumulation". Thus, we have devised an asset allocation system which rebalances accounts out of whack by big gains or big losses in one area or another over periods of about three years. By doing active rebalancing, we overcome the limitations placed on mutual fund managers to ply a certain style course (they only use a limited number of strategies to achieve their results, by prospectus). Perhaps more importantly, rebalancing allows us to do better than the averages in downturns.
With an active rebalancing strategy, we can even improve on the long-term performance of stocks and can reduce their volatility.
So what is the right allocation for someone with 30 years to retirement, 20 years, 10 years? Conventional wisdom says that the closer to retirement, one should hold fewer stocks to avoid a sudden depletion, resulting in less money. We think that this argument is flawed because it ignores the power of stocks to continue to compound, even into retirement. We would continue to be heavily weighted in stocks even into retirement, with the caveat that not being able to sleep out of worry dictates a more gentle approach. Still, if you think about it, investing does not begin when you retire - it can go on for another 10, 20 30 or more years, until your transition and the transfer of your assets to others - family, friends or charity. Viewed in this way, almost everyone has a 30-year horizon and should therefore have a large portion of their assets in stocks.
Now, would I place a lump sum in play in a stock market that has rallied for years? No, I'd want to average it in for a few years in order to reduce the risk that I bought in at the high. Our rebalancing strategy helps ensure that we don't make the "big" mistake.
Great wealth is obtained in stocks and real estate. Little wealth is accumulated in annuities, CD's and bonds. Though it takes great fortitude and confidence, we assert that common stocks and real estate make a much better set of assets than do safer instruments. But, we caution, what seems safer is actually more hazardous to your long-term wealth. The objective is simple: accumulate as much as you can and keep accumulating even in retirement.
Jim
Feel free to share this newsletter with others. Those wishing to receive future issues may contact us by email at jim.pursley@gaiacapital.com. Gaia Capital Management, Inc. is a Registered Investment Advisor, managing accounts for individuals, families, businesses and institutions. We welcome your inquiry about our services.
Jim
Pursley
Gaia Capital Management, Inc.
The opinions contained in this report represent the author's current knowledge and are based on sources known to him at the time of writing. Such opinions are subject to change at any time and are presented for educational value. Any other use, such as investment solicitation, is inappropriate and absolutely unintended by the author. Readers must evaluate information herein presented according to personal situations, goals and expected future needs.