Middle-class Income and Want to Beat Average Market Returns? Forget it!
John J. Hohn and dog Jessie
Most middle-class families didn’t have much wealth to begin with — about $100,000. For the 22 million families right in the middle of the income distribution (those making between $39,000 and $62,000 before taxes), about 90% of their assets was in the house. Now half of their wealth is gone and it will never come back as long as they live. Yahoo Finance.
As a boy, I loved cookies. Mother stashed them in a cookie jar, and I snitched. When the jar was pretty full, nobody noticed any missing. Once a glance produced a count, however, I needed more stealth.
The cookie jar metaphor applies to retirement funds also. It looks so ample at first that a snitching won’t matter. It does!. Snitch, and the next time will be that easier until a the point is reached when a glance tells that there isn’t enough left to get from one day to the next.
Most middle-class families have at least one retiree who will qualify for social security who will collect about $1,700 per month. Before retiring, income after taxes probably came to $4,500 a month. Retirement means a drop of $2,800 a month. Most households will not be ready for it.
Enter $100,000—the rollover 401(k) or IRA. What do we do with it?
We invest it—very conservatively. Maybe year-in-year-out we can get a total return of 7.50%, or an additional $7,500 to spend without invading the principal. $7,500 gives us an additional $625 each month. Added that to social security, we get a little more than half of the last paycheck.
The trouble is that middle-class families can’t count on averages for their planning. The average stock market return is calculated given about 80 years of experience. Not enough. Nobody would bet on a quarterback who had only thrown 80 passes in his career. Fortunately, analysts have developed a new tool called a monte carlo simulation that takes actual market experience, and using that data, promulgates probable and likely annual rates of returns for several hundred years—a virtual millennium. The simulation generates all kinds of scenarios, manipulating the sequence of market history, beginning with losses in some cases, beginning with huge profits in others. Then it weighs how r many times an investor, given the manner in which the portfolio is constructed, will come out OK and how many times he or she will fail and by how much. This may not be perfect but it is far better than using simple averages to determine how long whether our retired couple’s investments will last.
The next step in the simulation produces a percentage of likely success against our virtual millennium of market performance. Taking the amount invested and the manner in which it is invested less the planned withdrawals, the program will calculate the odds that the money will last as long as needed and express it in a percentage. With no return, the couple with $100,000 taking out $625 a month has a 100% chance of running out of money in less than 9 years. The monte carlo simulation will demonstrate how long the nest egg will last given how it is invested in most every possible market performance. An 80% or better chance of surviving the markets most likely to occur is an acceptable threshold most of the time.
If 80% cannot be obtained, other variables need to be considered including taking a part-time job, cutting back on expenses, staying a year or two more on the job before retiring, selling the home and buying a smaller place to cash out the equity in the property.
If your financial advisor is not using a version of the monte carlo simulator, find someone who is. Interview the candidates you are considering. Ask how much he or she has under management and how many clients are on the books. Divide the dollars under management by the number of clients and to get the average size client. Too high, say three-time the amount of your account is not good. Too many clients is not good either. 300 clients times 4 face-to-face meetings a year yields 1,200 meetings, which if divided by 50 weeks in the year, yields 24 meetings each week or nearly 5 every workday of the week. As a retired broker myself, 5 meetings a day on average is an upper limit for an advisor who has more to do each day than reviewing client accounts.
Don’t overlook the mutual fund companies that market directly to the public. They have the tools. Shop around. It’s your money after all.