Monday, February 4, 2008

Retirement Planning and “Under the Microscope”

The notion that seeing something up close, really up close was first championed by a relatively obscure scientist named Robert Hooke. Now seventeenth science was a sort of cutthroat business, with each new discovery lending itself to potential fame and fortune. Among Hooke’s contemporaries were Christian Huygens, Antony van Leeuwenhoek, Christopher Wren, Robert Boyle, and Isaac Newton. We’ll get to Mr. van Leeuwenhoek in a moment.

Hooke’s Microscope

Hooke set the stage in the early seventeenth century with his numerous accomplishments among which included the universal joint, the iris diaphragm, and an early prototype of the respirator. He is also credited with the invention of the anchor escapement (increased the accuracy of the pendulum and another mechanical clock function, the balance spring. Hooke also served as the Chief Surveyor helping to rebuild London after the Great Fire of 1666.

Anchor Escapement

Hooke pushed the theory of motors further along by working out the correct theory of combustion, devising "Hooke's Law" to describe elasticity, worked with Boyle on the physics of gases and is also credited with the invention or improvement of a wide variety of meteorological instruments (barometer, anemometer, hygrometer)

But as I begin the conversation on annuitized retirement, it is Antony van Leeuwenhoek that best identifies with what the average man can accomplish. In retirement planning, we are all “everyperson”, mostly ordinary with hidden talents and skills that often are undeveloped or fully realized. Antony van Leeuwenhoek invention of the microscope, actually a well-developed and honed magnifying glass gave the world, which tended to look to the heavens for answers, a closer peak at the world around them.

    “. . . my work, which I've done for a long time, was not pursued in order to gain the praise I now enjoy, but chiefly from a craving after knowledge, which I notice resides in me more than in most other men. And therewithal, whenever I found out anything remarkable, I have thought it my duty to put down my discovery on paper, so that all ingenious people might be informed thereof.”

    Antony van Leeuwenhoek. Letter of June 12, 1716

According to history, “Leeuwenhoek's skill at grinding lenses, together with his naturally acute eyesight and great care in adjusting the lighting where he worked, enabled him to build microscopes that magnified over 200 times, with clearer and brighter images than any of his colleagues could achieve.” Not bad for someone who sported no formal educational background and was largely without the fortune that many of his contemporaries were accustomed to using to further their studies.

Antony van Leeuwenhoek’s Microscope

Annuities demand that you understand one of the most complicated tools invented for the average person and their retirement plan. The instrument, part insurance, part mutual fund is hard to resist. It offers, to the unsuspecting, the opportunity to do two things: protect the ones you love and grow your money.

Unfortunately, this type of investment does not always perform as promised and those who believe it do often face a rude awakening when they try to exit. In this book we take our first hard look at annuities – there will be others in upcoming publications – since my first book, “Building Wealth in a Paycheck-to-Paycheck World”. Be warned: you may not like what you read.

Sunday, February 3, 2008

Retirement Planning and the History of Medicine


Retirement Planning and (a very brief and incomplete) History of Medicine

History doesn’t so much repeat itself as it traps us inside repetitive motions, sentencing us to do the same kind of things over and over, whether it is the best method or not. Unfortunately, this foible of human existence is not just a hapless mistake when it comes to retirement planning, but also something that can take quite a few years to correct. When it comes to medicine, established thinking remained unchanged for thousands of years.

At the beginning of chapter seventeen, I discuss just such a history and the influence it had over two millennia of medicinal practice. The chapter opens with a conversation about humors, often referred to as the study of body fluids (not so appetizing of a subject) is important for two reasons. It gives us a chance to examine some of the notions that you might have about investing and how those ideas have affected your retirement plan.

To add credibility to a subject, you must first be famous, something that wasn’t invented with the advent of paparazzi and if that fame was because of your associations, even more truth-in-wisdom worship was heaped upon you. Plato’s success was largely due to his place in history, before Aristotle and after Socrates.

I mention Aristotle (who believed the every soul knew everything and that we simply forgot what we knew at birth, and for the rest of our lives, we try to reawaken that knowledge), Plato (a student of Aristotle who opened the Academy in Greece to discuss and engage students about ideas and ideals, how the world was created and what makes a man – matter and free will) and Socrates (a student of Plato who pretty much invented modern logic with his causes: “material cause or what something is made of, efficient cause or the motion or energy that changes matter, formal cause or the thing’s shape, form, or essence; its definition and lastly the final cause or its reason, its purpose, the intention behind it) because this is a study in how things get passed along from one person to another. It was what one taught the other that allowed the other to make discoveries, conclusions and eventually, hypothesis. One of those passed along ideas was Plato’s notion of elements.

The classical Greek version attaches each of these elements to a specific god: Zeus is Air, Hera is Earth, Hades is Fire and Nestis (Persephone) is Water. Aristotle basically drew the organic line between all of them, giving them form. As John Opsopaus of the Computer Sciences Department at the University of Tennessee Knoxville writes: “Earth is predominantly Dry, Water predominantly Cool, Air predominantly Moist, and Fire predominantly Warm.

The dominant Power is the one in a counterclockwise direction from the Element in the Square of Opposition; thus the arrow by each Element points to its dominant Power. The vertical axis represents the active Qualities (Warm, Cool), the horizontal represents the passive (Moist, Dry). The upper Elements (Air, Fire) are active, light and ascending, the lower (Water, Earth) are passive, heavy and descending. The Elements on the right are pure, extreme and absolutely light (Fire) or heavy (Earth); those on the left are mixed, intermediate and relatively light (Air) or heavy (Water). The absolute Elements exhibit unidirectional motion (ascending Fire, descending Earth), whereas the relative Elements (Air, Water) can also expand horizontally. The Organic Cycle (the cycle of the seasons) goes sunwise around the square.

When Hippocrates made the leap from observed sciences and gave these definitions of the elements to the human body, did we enter a dark age for medicine. Even as more and more new discoveries were being made in the subsequent centuries, many of those discoveries were shaped (almsot hindered) by these ingrained notions that, if some fluid was involved, it pointed to a certain malady.

Much of what you know about retirement planning revolves around ideas that may be more antiquated than useful. Just as doctors, right up until the middle of this century associated these elements as precursors for their decisions, the way we focus on retirement has changed. None of what you may know, stocks to bonds protectionism, a balanced attack, shifting as we get older, is what we need in this day and age.

In the perfect retirement account, one that is not an investment but an investment in the future, I believe that stocks should always be held, right up until you retire and often beyond. But because the book doesn’t necessarily go beyond the point of retirement – if there is an actual definitive date for that event – the focus on what you should do up until that point is much different that what you have heard before.

Friday, February 1, 2008

Retirement Planning and Optimally Saving

This is the popular notion:

    “A long time ago, New England was known for its thrifty Yankees.
    But that was before the baby boomers came along. These days, many New Englanders in their 30s and 40s, and indeed their counterparts all over America, have a different style: they are spending heavily and have sunk knee-deep in debt. . . A recent study sponsored by Merrill Lynch & Co. showed that the average middle-aged American had about $2,600 in net financial assets. Another survey by the financial-services giant showed that boomers earning $100,000 will need $653,000 in today’s dollars by age 65 to retire in comfort—but were saving only 31 percent of the amount needed. In other words, the saving rate will have to triple. Experts say the failure to build a nest egg will come to haunt the baby boomers, forcing them to drastically lower standards of living in their later years or to work for longer, perhaps into their 70s. (Wall Street Journal, Wysocki 1995, A1)”

And here is the contrarians view:

John Karl Scholz (University of Wisconsin–Madison and National Bureau of Economic Research) Ananth Seshadri (University of Wisconsin–Madison) Surachai Khitatrakun (Urban Institute) suggest, in a paper titled “Are Americans Saving ‘Optimally’ for Retirement?" the following:

“We solve each household’s optimal saving decisions using a life cycle model that incorporates uncertain lifetimes, uninsurable earnings and medical expenses, progressive taxation, government transfers, and pension and social security benefits. With optimal decision rules, we compare, household-by-household, wealth predictions from the life cycle model using a nationally representative sample. We find, making use of household-specific earnings histories that the model accounts for more than 80 percent of the 1992 cross-sectional variation in wealth. Fewer than 20 percent of households have less wealth than their optimal targets, and the wealth deficit of those who are under-saving is generally small.”

So who is right? And as I ask in the book, “How could you save too little?” The authors use a stochastic (from the Greek for guess) life cycle model that, it should come as no surprise is what the insurance industry uses when they do actuarial estimates. But that is another book.

The authors look at “precautionary savings and buffer stock behavior” as well as “end-of-life uncertainty and medical shocks”, what they call “the evolution of average effective federal income tax rates over the period spanned by our data” and “realistic expectations about earnings; about social security benefits, which depend on lifetime earnings; and about pension benefits, which depend on earnings in the final year of work.”

Using that info they then began “calculating optimal life cycle consumption profiles.” They were also concerned with “he timing of earnings shocks can cause optimal wealth, which can “vary substantially, even for households with identical preferences, demographic characteristics, and lifetime income.”

And based on that, they wrote, “We find that over 80 percent of households have accumulated more wealth than their optimal targets.”

To make this claim, they offer the following as way of quantifying that statement. “Households typically maintain living standards in retirement by drawing on their own (private) savings, employer-provided pensions, and social security wealth.” Private savings is described as “housing assets less liabilities, business assets less liabilities, checking and saving accounts, stocks, bonds, mutual funds, retirement accounts including defined-contribution pensions, certificates of deposit, the cash value of whole life insurance, and other assets, less credit card debt and other liabilities. It excludes defined-benefit pension wealth, social security wealth, and future earnings.”

In short, and you can read the entire paper here, we fail to calculate what we have in assets, our ability to accumulate wealth over the course of our working careers, and our changing life style habits which could allow us to downsize quite effortlessly, giving us access to accumulated wealth equity in our homes.

Key is to this savings is keeping debt manageable and low as you enter the waning years of your working career.