How Much Will I Need To Be Able To #Retire?

So... you're thinking about retirement? 

At the risk of getting overly philosophical (which I plan to do later), maybe I should first ask what that means.  

Sometimes people say they just want to relax, and I respond by asking "how long will it be before you get bored?"  At other times people say they would like to travel, and I respond by asking "and what will you do when you get back?"

But, let's assume we're all saving for retirement - which is unconditionally a good idea - and the question is "how much do I need to save in order to retire?"  

I'm going to start by assuming that the Social Security net is broken, the system is bankrupt, and you have to be able to take care of yourself.

By way of an example, let's assume net (after tax) household income of $40,000 and monthly expenses of $3,000.  Out of the gate, applying simple math, we can deduce that spending $3,000 a month equals $36,000 which, in turn, leaves you able to save $4,000 (or 10% of net income).  Note two important points: (1) you must spend less than what you earn; and (2) you must save at least 10% of your net income. All good so far?

Now, the second critical step is to ensure that you have at least 12 months of living expenses in cash, in the event of a job loss, illness or other unexpected expense.  That means you already have $36,000 saved.  Still good?  If not, and you're reading this... you've already made progress!

Now... many smart financial advisors - people far smarter than me - suggest that your investment portfolio should include about 10-15% cash (or assets that can quickly be turned into cash, like stocks).

If $36,000 equals 10%, then 100% equals $360,000.  That's probably a good minimum savings target.  Minimum, because - when it comes to money - more is usually better!

But, $360,000 returning approximately 7% (see other, related postings on relatively safe, blue-chip investments) will return about $25,000 annually.  In reality, this means that if you're currently spending $3,000 (as per my example above), your will be required to cut your expenses by $1,000 a month.  This may be easy, because if you're not working, you may not need to shop for new clothes as often, pay for transport, buy lunch, etc.  Or, this may be difficult because you're already living a simple life (not shopping much, walking to work, making lunch at home, etc.).

The greatest ongoing cost for most people is rent or a mortgage, and you need a place to live in.  Can you downsize your living arrangements?  Perhaps the availability of some Social Security benefits (in the future) will add to your monthly income?  Could you relocate to a less expensive town/city/country?  Could you work part-time in retirement and call yourself semi-retired instead?

Back to the example above: In order to deliver about $36,000 an investor would need about $500,000 invested at 7%.  If you can generate a higher return, you can get away with less savings.  If you're going to invest in 'safe' securities, like bonds, you will need more savings.

Either way, it's never too late to start saving!  

Typical middle-class, salaried employees should NOT contemplate retirement with debt, or having to rely on government support.

If you are currently spending $3,000/month and you are in reach of that initial goal of $360,000 demonstrated above, you're well on your way to self-sufficiency in retirement.  

Don't rush to stop working and earning a living, and keep saving.  When you are ready to relax and enjoy the fruits of your labor... happy retirement!

How Much Cash Do I Need?

People often ask " how much cash should I keep in my investment portfolio?" 

This is a difficult question, because the answer will differ depending on each person's unique & personal, existing financial situation, and their ongoing cost of living requirements.

Having some cash in an investment portfolio is beneficial, at the very least to enable the investor to purchase a really good company stock when it is offered "on sale".  See the related post: "How to make money on blue-chip stocks".  A cash allocation of 10-15% (of the total investment portfolio) may make sense to an average investor.

Financial planners usually suggest, and most would probably agree, that the average salaried employee should have enough cash on hand (or other liquid instrument that can be turned into cash quickly e.g. stocks that can be sold), to cover ongoing household expenses for at least 6 months.  Of course, 12 months may be better, or preferred, as a safety net!

But, too much cash on hand is not a good thing, because the opportunity cost of losing investment returns on cash deposits in a bank account (or under your mattress) is high.  Cash deposits that exceed the suggested safety net of 6-12 months above represent a lost opportunity to earn passive income, or may deliver a 'net negative' return on investment (e.g. when adjusted for inflation)!

In a previous posting I had remarked that even relatively safe investments (safe investments often deliver lower returns) - e.g. in a basket Dow stocks - could easily average about 7% annually.  For more detailed information about the Dow Jones Industrial Index performance during the past century, you can view this blog site: Observations.

In reality, my positioning is conservative. According to Observations (presenting data easily verified elsewhere): "from ’33 to ’65 the average return was about 7% per year and with reinvested dividends, approximately 10%. From ’82 to ’99 the average return was about 15% per year."

At a glance then, you can see that cash in the bank earning interest at e.g. 0.1% represents investment opportunity lost, as mentioned and described above vs. a relatively safe investment in a basket of Dow stocks.  

Note, I suggested "a basket" of Dow stocks and not a Dow stock (as in singular).

If we review the Dow 2012 YTD change, you will notice that performance of the entire index of 30 stocks for this year, to date, is 7.67%.  No big news, because it matches the 100-year average performance mentioned previously.  But, pay special attention to the outliers: Bank of America (NYSE:BAC) is up 91% YTD, but Hewlett-Packard (NYSE:HPQ) is down 46% YTD.  Clearly, an investor who only bought Bank of America stock would be delighted... but the HPQ stock investor... not so much!

In the next post we'll explore the follow-up question: "How much will I need to be able to retire?"

Now of course, this question is even more difficult to attempt to answer, because the variable components to this question include for example where you live (country, city, etc.), ownership/rent of your current home, ongoing expenses, whether you are willing to reduce your spending, current saving and spending habits, debt (you're not thinking of retirement while you have debt, right?), and so much more.

There are many professional, licensed financial planners who have the ability to work diligently with investors to arrive at a detailed analysis and attempted answer to this question.  We'll review a high-level attempt at answering this question, in the next post.

Later, we'll explore the philosophical question: "What is retirement anyway?"

Diversification: "Old Wall" vs. "New World"

"Don't put all your eggs in one basket!"

"Old Wall" is a common Twitter hashtag (#OldWall).  It is used to describe Wall Street investment bankers, traders and advisors who are steeped in tradition, supposedly out of touch with the modern trading trading environment (e.g. where trades are executed in milliseconds), people who spend large amounts on their personal appearance to be able to present as successful bankers - you get the picture!

"New World" has no such description; I simply made it up to imply the inverse, or opposite, of #OldWall.

Investment advisors have traditionally, and quite correctly, advised their clients to diversify.  This often meant that the client's savings would be distributed across different asset classes, or investment vehicles, in order to help mitigate risk of losses.  

For example: let's say you had investments of $1,000 each in gold, healthcare and energy: Oil went up while a little, the price of gold remained static, and healthcare stocks 'took a bit of a hit' because of new legislation.  Spread equally - or diversified across all three - the investor may have avoided a gross loss, because her gold is still worth $1,000; perhaps the energy stocks are now trading at $1,100, and the healthcare investment is worth $950.

"Don't put all your eggs in one basket, and diversify each basket even further!"

So... here's the "New World" philosophy:

Not only do you place your eggs in more than one basket, but you also place a variety of different eggs in each different basket.  

Let me explain a little further... if we assume each basket in the image immediately above (respectively) equals the one, single basket at the top, then I am able to diversify even further. If one of the little baskets above holds equity (stocks, bonds, ETFs) spread across different assets (like energy, healthcare & gold in my example above), I still have two baskets remaining to diversify and mitigate my investment risk even further.

I would imagine that a second basket may hold a mix of liquid assets, like cash (and variations of cash, e.g. interest-baring savings bonds or certificates).  One can diversify cash in many different ways, including deposits held in a stable currency (e.g. British Pound Sterling) if you live in a country with a volatile currency.  Holding at least 6-months worth of cash to cover the possible risk of unexpected illness or loss of a job makes reasonable sense.  More would be better!

A third basket is then available for illiquid assets (e.g. investment properties), an annuity, and perhaps even some higher risk, greater return stocks - or investments in faster growing companies than Dow blue-chips that typically average 7% annually.  Note that higher risk, higher returns also exposes you to higher risk, greater losses, but now you're down to 5-10% of you entire portfolio.

Note that a house you live in would typically not be viewed as an investment, unless e.g. you're renting out rooms to tenants while you live there.  Anything that costs you money on a regular basis is not an investment (except perhaps in accounting terms), but a current liability.  If you live in a house and your income from that "investment" is $0 monthly; and your property tax, utilities, maintenance, etc. costs you $1,000 monthly - this represents a $1,000 ongoing current liability.

If - in the future - you were to sell your house that you had been living in for some time, for an amount that is significantly greater than what you had paid for it originally (compounded at say >5% per annually; because you can do better than that in the stock market), it may then be view as an investment, at the time of sale, that delivered a (hopefully) positive return.

Challenge: Do a time value calculation to determine if a $350,000 house bought in 2002, that is sold for $500,000 in 2012 is a good investment, or not.  If you need help, ask me!

In investment terms, assets deliver continuous passive income, not continuous cost!  Take caution so as not to confuse fixed assets (the house you live in) with investments (that generate income).

A new world diversified portfolio does not only spread investments across different types of equities (or similar), but across different asset classes too.  An investment advisor may not want you to become a landlord, or have too much money in the bank (of course, you may not want either, but you have choices and alternatives to consider).  The reason for the aforesaid is simply because an investment advisor typically earns commission on trades made on your behalf, and she cannot earn commission on e.g. your investment property income or on your interest on cash deposits

When someone offers you investment advice for a fee, and you want to trust them with your hard-earned cash, always limit the access you give them for managing your wealth to a portion (e.g. one small basket) and not the entire portfolio.

Have fun... because investing should be fun.  And if it isn't fun... then change the way in which you're managing your investments!

What is an ETF?

People invest in many different types of vehicles, or investment instruments.  In this post, we'll briefly explore an ETF and compare it to its most logical alternative investment choice.

ETF = Exchange Traded Fund.  It's an investment that is traded just like other company equity on a stock exchange, e.g. the NYSE. The key elements included in this short description are that an ETF can be traded like stock (i.e. via an online brokerage account), and - perhaps more importantly - that an ETF is a fund, not dissimilar to a mutual fund or other 'basket' of investments.

An ETF therefore holds a variety of assets like stocks, commodities, or bonds.  These funds then typically track or mimic another index, such as the Dow Jones Industrial Index (commonly called the 'Dow'; and widely regarded as a primary benchmark of the day's stock market activity).  

Unlike owning stock, ETF investments are typically subject to annual fees, although the fees (or costs) related to ETF investments are generally lower than comparative fund investment instruments, like mutual funds.  Investors who trade ETFs are trading their shares on a secondary market, but I'll provide more information about that later, on another posting.

ETFs have been available in the US for about 20 years.  In 1998, State Street Global Advisors issued an ETF for investment, called SPDR Dow Jones Industrial Average, traded under the ticker symbol "DIA".  I picked this one as an example, because it will allow me to compare DIA to the Dow, which itself is a basket and index of 30 'giant' stocks.  You can view the large corporations that are included in the Dow here.

The basket of stocks included in DIA is described in their prospectus, which you can view here.  Their top fund holdings include these Dow heavyweights:

DIA Fund Top Holdings as of 12/03/2012

Name	Weight	Shares Held
IBM	11.22%	6,216,774
Chevron	6.20%	6,216,774
3M	5.35%	6,216,774
Exxon Mobil	5.19%	6,216,774
Mcdonalds	5.16%	6,216,774
Caterpillar	5.00%	6,216,774
United Technologies	4.73%	6,216,774
Boeing	4.38%	6,216,774
Wal-Mart Stores	4.22%	6,216,774
Travelers Companies	4.20%	6,216,774

Any investor could mimic DIA (in other words you could buy the same stocks as the super smart fund managers at State Street), without having to pay any fees (other than one-time brokerage commission when you buy the stock).  

The top fund holdings listed above gross up to just over 55% of the DIA fund's investments (we didn't investigate the other 45%).  Remember that State Street has skilled traders who are able to open and close positions (buy and sell stocks) quickly and expertly, and who are using smarter trading tools than amateur investors have, etc.  One could therefore argue that paying a low annual fee may be worthwhile for the expertise State Street Advisors offer in managing your investment (according to the Morningstar Investor Research website, State Street's fees for DIA is <0.5% annually).

Another observation one can make about the table above is that although the percentages differ, State Street holds the same position (number of shares) in each of these equities listed.  The percentages differ because each stock has a different price, multiplied by the number of shares held.

So let's assume you have $10,000 available for investment.  You could buy about 76 shares of DIA (current price ~$130), or you could buy $1,000 worth of shares in each of the 'ten fund top holdings' above (respectively), and end up more or less in the same place.

The difference on an ongoing basis would be nominal, but may become significant over the longer term.  There are pros and cons both sides of the equation: If you buy DIA, you only have to make one purchase, but you incur a nominal ongoing 'fund management' fee.  If you were to buy the 10 different stocks directly you would own them outright after paying brokerage commissions (no future fees).  But... you would then be required to manage your investments 'self-serve' and pay attention to your investments to mitigate financial loss in the longer term.  Many people would prefer to have a professional fund manager doing this on their behalf, especially at minimal ongoing cost.  However... even a minimal fee compounded, e.g. over 20 years, adds up to an amount of lost savings that could be considered material to your investment portfolio value in the future.

On the graph above I've compared the performance of DIA vs. 5 Dow stocks for the previous 5 years. The DIA performance is reflected by the light blue line at the bottom.  The 5 Dow stocks were selected because of recent mixed performance.  What's observationally interesting is that all the stocks, along with DIA, follow more or less the same pattern in the graph.

What's more important is that the 30 stocks that make up the Dow, have consistently delivered about 6-7% year over year, for more than 100 years.  This average includes major events that had impacted the stock market, e.g. pre-war recession, 9/11 events, the 2008/09 financial market meltdown, etc.  

So, instead of having cash safely tucked away under your mattress or in a bank savings account, you should know that you could have a consistent return of around 7% by simply investing in a basket of Dow stocks, longer term.  I'm very confident that this beats the return paid by your bank on savings accounts!


However, three further points of clarification are required: (1) find a great company to invest in and buy it - i.e. don't trade these stocks regularly, because if you do, you will likely lose money; (2) reinvest all dividends while you're earning an income - i.e. don't withdraw any gains unless you absolutely need the cash; and (3) buy when it's red and sell when it's green - i.e. when blue chip stocks go down e.g. because of quarterly results, that's usually a signal to buy; and if the stock you already own is in the red, don't sell unless there's a compelling reason to do so!  

The objective is simply never to take a loss, because over the longer term, you never really need to, if you invest in a basket of Dow stocks.

[You may also be interested in the post "How to make money on blue-chip stocks"] 

Homeless in America

I currently live in San Francisco.  This morning I was walking to work.  I saw a homeless Vet pushing a wheelchair, probably to a more favorable money-collecting location, I assume.  I didn't judge him for pushing his wheelchair... it's only an observation.  I knew that he had served his country in combat before.  He was wearing a baseball cap that said "U.S. Navy Veteran."

I don't understand homelessness, and cannot imagine a solution.  The population demographic split in the city between 'homeless' vs. 'have home' seem about equal, at least on Market St. anyway.

So, the guy above was pushing his wheelchair, wearing his cap, looking sad and somewhat disheveled (I'm being polite).  Not knowing his unique circumstances, I thought that in his previous career he may have excelled in marketing, because the 'get-up' that includes passing off as a Veteran (whether real or not), sitting in a wheelchair, along with looking sad and forlorn... beats the very average "spare some change" guy's get-up, hands-down, any day.

I Googled "how to solve homelessness," but found a link to Mobile Homemaker's blog instead, entitled "Survival Guide to Homelessness".  You can read it here. 

He says that "no one understands what you are going through. People who know you are homeless are constantly trying to cure you of the condition. Cure you, like you have a disease." And "as a homeless person, I do not want someone to feed me. I do not want someone to house me. I do not want a blanket, and I will not work for food! You have to ask me what it is I need if you want to have an effect."

These comments made me even more confused, because all the things he said he didn't need, were the things I thought homeless people would want.

Fortunately, he also added his requirements for assistance:

"I've thought a long time about what would be useful to the homeless. We need public toilets. Not filthy portapotties, but proper restrooms that are private and clean. We need safe places to sleep. Capsule hotels, which are found in Tokyo and some other places in the world, would be most excellent. The rooms should be very cheap, and I mean five bucks is too much. They should be subsidized, and there should be twice as many as there is a demand for them. They should be extremely secure, and you should be allowed to stay for as long as you want. We need showers. Safe, secure, single occupancy showers. Those are answers that would help people."

I think his demands are reasonable, but I'm not confident that he and his friends would be willing to make a positive, ongoing contribution, assuming his needs were ever met.  For one, the most basic ask of "private and clean" restrooms may be just that when provided at first, but for how long?  And the same would be applicable to "safe, secure, single occupancy showers." 

I think it unlikely that people who take care of their own homes would cause restrooms/showers for homeless people to lack privacy, security and cleanliness.  In fact, it's likely that people who expend an effort to maintain their own homes would not even be likely to utilize the public amenities created for the homeless people.  So my question to Mobile Homemaker would be: "If I have to provide these amenities for you at my cost, would you and your friends respect the amenities with as much pride and compassion as the people who "subsidized" them on your behalf?"

My family and I manage and operate a 501(c)(3) charity called Memory Trees.  We don't make/take any money from it, using 100% of donations received to plant trees in public spaces.  Our charity is probably of little benefit to homeless people, save perhaps to provide some shade on a sunny day or cover in the event of inclement weather.  But, we do fund the planting of fruit-baring trees in low income areas.  That could be of benefit to homeless people.  Maybe we can declare San Francisco a low income area?  Perhaps we should ask 'City Hall' if we could arrange some donations and planting of fruit trees in San Francisco public spaces.  Mobile Homemaker - would that be of any benefit to you and your friends, even though you said you don't want someone to feed you?  As in, if you were to pick it yourself, that may engender a sense of pride.  I'm only asking, because I don't know.

In May 2011, the San Francisco Human Services Agency released their findings following surveys conducted with 1,024 people at emergency shelters, transitional housing facilities and other sites throughout the city.  It was part of a biannual study of San Francisco's homeless population, which is required by the U.S. Housing and Urban Development Department in order to authorize funding. The city typically receives $18 million in McKinney-Vento Homeless Assistance Act funding, the primary federal legislation dealing with homeless shelter programs in the U.S.  Just to prevent my Republican friends screaming "entitlements!," I should add that this Act was was passed and signed into law by President Ronald Reagan on July 22, 1987. 

That means we're already paying for Mobile Homemaker's needs via our tax contribution - $18 million is probably sufficient to provide some clean, safe and secure ablution amenities?  I don't know though, because I don't have any standing or knowledge regarding the cost of building and maintaining public amenities.

It's also possible that the bureaucrats of the City of San Francisco may prefer the annual HUD payment of $18 million, in preference to the actual task of addressing and/or trying to fix the city's socioeconomic problem of homelessness... but I have no standing or knowledge about their preferences in this regard either.

How to make money on blue-chip stocks

NYSE:JPM

On June 4, 2012 J.P. Morgan stock fell to $31/share after April/May 2012 trading losses were made public.  The Chief Investment Office said the losses were based on transactions booked through its London branch. A series of derivative transactions involving credit default swaps (CDS) had been entered into as part of the bank's hedging strategy.  The trader, nicknamed "the London Whale" had accumulated outsized CDS positions. An original estimated trading loss of $2 billion was announced, with the final actual loss expected to be substantially larger.

For the average investor, CDS positions, hedging and "whale-sized trades" are not important.  What is important is that the stock went on sale, creating a buying opportunity for long investors (long investors plan to own the shares, or buy them and hold them for a period).

If you had bought JPM at $31.00/share in June, it would be worth $41.00/share today, delivering a return of  32% on investment in less than 5 months.  When a corporation with a valuation of $152 billion goes on sale, it's usually a buying opportunity, but make sure that you investigate the facts that had caused the loss in valuation, before jumping in!

NASDAQ:CSCO

On May 21, 2012 I opened a long position in Cisco Systems, Inc., another blue-chip Dow stock.  

Cisco is valued at around $100 billion. The corporation designs, manufactures, and sells Internet protocol (IP)-based networking and other products related to the communications and information technology (IT) industry and provide services associated with these products and their use.

On May 9, 2012 Cisco stock had closed at $18.78/share.  But, after announcing poor results for their last fiscal quarter - as had happened several times before - we saw Cisco's shares tumble over a few days to just under $16.00/share, a drop of >10%.

To a counter-intuitive investor, this means that the stock was now priced to buy.  While some (mainly smaller) investors closed their positions (i.e. sold their stock) at a loss, other investors open new long positions (buying shares to hold), benefiting from the discounted, low price.

This stock, like any other, will ride the market's up and downs.  If you went long on Cisco towards the end of May or early June 2012, you'd be up by >15% in the 6 months or so since "the stock went on sale" in late May.  This gain is despite the stock hitting a new YTD low on July 24 2012, of $15.12/share.  On Friday, December 7 2012, Cisco's stock closed at $19.33/share.

I have opened and closed positions on CSCO periodically, but without actively trading.  I simply limit losses as best I can, and take profit when I have achieved a satisfactory return on my investment.

If you want to enjoy a positive return, pick up the stocks of these giant corporations when they go on sale, but carefully, doing a little research... and buy when they're red (and on sale), selling when they're green... not the other way around, and without emotion!

Disclosure/disclaimer: I'm currently long on Cisco

The summary above does not constitute investment advice by a professional investment advisor, but rather an attempt at simplifying the complexity of the timing of equity investments, that most inexperienced investors have to ponder.

Taxes are great!

I drove into Santa Barbara CA last weekend for an overnight stay.  Debbie and I were sightseeing.  We had not been there before.

We walked into our hotel lobby and found a flyer called "2012-2013 Free Map, Santa Barbara, Solvang, Buellton & Ventura - Traveler Info Guide."  The map shows all the scenic attractions in the immediate area and there are plenty wonderful sights to see.  So I thought this map was a good use of taxpayer dollars, albeit for a non-essential service.

I probably shouldn't have looked at the fine print, because before that I actually thought that they had used their residents' taxes to publish a map for people like me, who come to visit and spend money in their city.  But it was published by Anne M. Fearn, of Fearn's.  If you're going to Santa Barbara, you can download the map here.

Offering tourists a map of their city would likely be beneficial to the city (and its advertisers).  The city could probably have used taxpayer funds to publish its own map.  But, funding the publication of the map is simply micro symptomatic... it's more about the macro issue.  Their current Fiscal Outlook Report (Oct 12) states:

"It is currently anticipated that there will be a budget gap of $14.9 million in FY 2012‐13. The budget gap can be solved through a combination of strategies including ongoing measures such as increasing efficiencies, increasing revenues, and decreasing levels of service, or one‐time measures such as utilizing prior year savings and existing fund balance."

We know that government is unlikely to increase efficiency.  Increasing revenue is a disingenuous way of saying they're going to raise taxes (again).  Levels of services are at an all-time low already according to the locals. Utilizing prior year savings and existing fund balances is government speak for "robbing the till to pay the bills."

So now I don't like Santa Barbara any more... mainly because they have mismanaged their finances.  But I like the county, because it's easy on the eye.  Damn map that started it all!

But, we'll probably visit sometime in the future again, because the drive south on Highway 1 from Half Moon Bay to San Simeon is real easy on the eye, and very relaxing with frequent stops.

California's State deficit estimate has just hit $16 billion, which is a surge from the $9.2 billion estimated in January.  It also means deeper, more painful cuts, according to Governor Brown.  There is no obvious fix in sight, and seemingly no political will to address to underfunding of California State liabilities.  Santa Barbara is just a symptom of a brewing and simmering macro financial disaster!