Thoughts on Pensions and Retirement
How bad is the pension fund issue. Is it a crisis as the Pension Benefit Guaranty Corporation (PBGC) claims? Or is the American Benefits Council right when they say the problems are blown out of proportion? And depending on your assumptions, they could both be right. Examining this debate will provide a useful springboard as we examine retirement issues you may be facing.
But first, last week I promised a special announcement. Ready to ship and in a bookstore near you is my new book called Just One Thing. Some of you may have received an email yesterday about the book, and a lot of you ordered, because it is now #4 on Amazon in less than 24 hours! Permit me to make a few personal observations about the book and the publishing process.
With my last book, Bull's Eye Investing, I announced two years in advance I was writing it, and kept postponing the publication date. My "book-in-progress" I called it, but at times there seemed to be little progress, which did frustrate more than a few of my readers. This time around, we decided to wait until the books had been shipped to the bookstores to make the announcement.
Bull's Eye Investing did very well, making the New York Times bestseller list and a number of other bests-selling lists. The reviews were better than I could have hoped. It is still selling at a steady pace. Thanks to everyone who made that possible by buying the book. I am truly grateful.
So, it is natural that my editor at Wiley, Debra Englander, wanted me to do another book, and "By the way, what time this year can I have it?" But I gotta tell you, I just don't have another almost 500 page book with hundreds of footnotes and 20 pages of bibliography in me. Not this year, at any rate.
So I did something even better. I got 11 of my friends to write chapters. "Just One Thing," I told them. "Give me the one Best Idea you have learned about investing - the one thing you are personally most passionate about - that you want to pass on to your kids."
I am proud of this book, gentle reader. There are 12 great chapters from some of the smartest minds I know. One of the great things about working in my world is that I get to run around with some very smart, very successful people, who also happen to be very good investors. I get to pick their brains and learn from the best. If you could get a chance to sit down with Richard Russell or a Gartman or Kessler or Gilder (or Shilling or Arnott or the rest of the writers of my new book) most of us would leap at the chance. What is one idea worth if it helps us become better investors, or saves us the pain of losses?
The authors of these chapters have all learned a lot along the way. "Why not," I thought, "ask them to share the wealth of their wisdom?" And so I did. The rules of the book were pretty few. I told them to write me a chapter on a subject they had expertise in and thought was one of the special insights they had picked up in their time. I gave them no minimum or maximum word length. Make the chapter long enough to cover the topic. As you will notice, some chapters are quite short and others are feature length.
"Make it readable and understandable to the average person," I told them. "Nothing is more frustrating to me than a great idea you can't understand. I want something you are passionate about. Make it something that will give my readers an 'aha' moment. It will probably be something you have worked on for a long time. Maybe you already have the basic outline or material done. Just share it with us."
Now, I could guess what a few of them would write about before I asked. Mark Finn was going to write about the problems of past performance. He is absolutely brilliant on that (and a lot of other things), which is why he gets big institutions to keep coming back for his consulting. And you knew that Dennis Gartman would write on his Rules of Trading. Gartman has forgotten more about trading than most of us will ever know. Which, he would tell you, is why he writes his rules down so he can remember them and follow them! You break these rules, you are gonna lose. If you want to trade, you need these near your desk.
But a lot of the others had me curious as to what they would contribute. Many of them could have done several chapters or even books, (and most of them have!). But to cut it down to Just One Thing? That was hard.
OK, Andy Kessler gives us two. But when you turn $100 million into a cool $1 billion, and get out at the top, two ideas are a good thing. Kessler shows how investing in what everyone already knows is how to get average returns (or less!). Better, he says, to invest like you are walking in a fog. This chapter is so compelling and well written, I guarantee you cannot put it down once you have started.
Gary Shilling shows us the value of one really good idea. It made his career. George Gilder tells us that in fact inside information is the best information. I leave it to you to read why. Bill Bonner tells us that we need to first start with a principle if we want to succeed and then shows us his idea as to what that is. Mike Masterson looks at the same thought, but comes away with an entirely different take.
Want to average almost 3% a year better on your funds? Rob Arnott writes compellingly that the way index (and many mutual) funds are currently constructed is inefficient and offers a new way to invest. This powerful analysis could be worth a lot to you. My side prediction? The revolutionary new indexing method that Arnott lays out will be the dominant index investing style within ten years. Arnott will go from running almost $10 billion today to several hundred billion in a few years and within ten will eclipse the large index funds like the Vanguard S&P 500. A bold reckless prediction? Not at all when you understand what Rob has done. Rob has found a way to put fundamental value into index investing. It is worth an extra 3% a year. Now THAT is a chapter you will want to read.
James Montier gives us a very thorough overview of the latest research on the human foibles in investing. He is an expert on the psychology of investing, having literally written the book. In fact, his book is one of the textbooks used to teach the subject. I got him to give us a very easy to read summary. This is one you will want to read and re-read and come back to often.
Richard Russell, who has been writing The Dow Theory Letter since 1958 and is the dean of economic writers, gives us his thoughts on time, hope and the power of compounding. Anytime Richard talks, we should listen.
My good friend Ed Easterling shows us that risk is not a knob. "The first step toward making money is not losing it," he writes, and shows us how to avoid unnecessary risk while making it our friend when we do encounter it. Isn't that something we all want to do? Ed shows us how.
And finally, I weigh in with a few thoughts on the power of change in our future. The pace of change is accelerating, and we not only need to know what is changing but how to take advantage of it. The best investments of the next 20 years will be those that are part of the process of change. I call my chapter The Millennium Wave. I have been working and thinking on this topic more than any other for the last ten years.
I am proud of this book and the work my friends have done to bring you their one best idea. I believe you will find many nuggets you can use in your own life and investing. As to the order of the chapters, it was just too much to decide who should be first and then second and so on. Each chapter is a "lead" chapter. So I let the way they were organized in my inbox be the prime factor. So, start at the beginning or in the middle or the end, but read them all.
And Just One More Thing. There are a lot of great ideas in the few hundred pages of this book. But you have to put them in practice, and to do that you have to get the book and start reading it now. So as you read, think about how you will put the principles, tips and ideas to use in your personal life. And that will make this book be a very good thing.
You can get Just One Thing at your local bookstore or order it at a 34% discount from Amazon.com as part of a special promotion to celebrate the. Don't procrastinate. Order your copies from Amazon at just $16.47 and copies for your friends and family at the special price. Get two and get free shipping! www.amazon.com/justonething
Can I Ask a Personal Favor?
If you are planning to buy a copy of Just One Thing, would you do me a favor and do it this weekend on Amazon or your bookstore? Having a high rank on Amazon actually helps bookstore sales, and bookstore sales mean they order more books and give the book better placement. Getting off to a big start is really very helpful. I know I and my fellow writers would appreciate it.
And I guarantee the book will make a great Christmas present. It is fun and easy to read. Did I mention I was proud of this book and the work my friends put into their chapters? So buy a few extra while you are online! And now back to some thoughts on pension funds and retirement.
Corporate Pensions Down $450 Billion and Counting
This week I came across a very thoughtful article entitled "The End of Pensions" by Roger Lowenstein in the New York Times. (Lowenstein wrote a great book on the Long Term Capital debacle called "When Genius Failed.") He makes the case that corporate pensions are underfunded to the tune of $450 billion. Public (government) pensions are underfunded at LEAST another $300 billion. "According to Barclay's Global Investors, if you use realistic assumptions, the total underfunding in all public plans is on the order of $460 billion. If this figure is even close to true, future taxpayers will be hopelessly in hock to the police, firefighters and teachers of the past." (NYT) But that is not the whole story.
I wrote two years ago in Bull's Eye Investing that the firms in the S&P 500 which had defined benefit pension plans were underfunded by $243 billion (CSFB study). The same group suggests that these same companies will still be underfunded by $218 billion at the end of this year. Think about that. We have seen the market rise almost 20% since that first study, profits at corporations have sky-rocketed, and yet liabilities only dropped 10%. Even in a rising market, the companies did not make significant headway in solving their pension problems.
Now, most of that liability is from companies that are solvent and at the end of the day will be able to meet their pension obligations. But a significant portion will not be able to. The PBGC tells us they are $23 billion in the red at the end of 2004. This is expected to rise to $30 billion when the books for the third quarter are closed. A Congressional Budget Office (CBO) report last week predicted a jump in PBGC liabilities to $87 billion over the next decade and $142 billion in 20 years. For reasons outlined below, I think it could be worse.
But the American Benefits Council (ABC) says the PBGC is overstating the case in order to get additional funding. In a recently issued report, the Council concluded that the interest rate used to calculate pension obligations, now less than 5%, is too low, and that the PBGC shortfall would be only $14.3 billion if a 6.2% corporate bond rate were adopted. That makes a nice assumption, as AAA corporates are paying 5.39% today. To get an average 6.2% you have to move out toward riskier bonds, which PBGC is unlikely to do.
In the last three years, almost 600 companies have reneged on pension-fund obligations, with 21 plans each totaling $100 million or more, topped by United's pension fund failure at $9.8 billion, the biggest since the government began guaranteeing pensions in 1974. In June, Delta Air Lines and Northwest Airlines told Congress their plans would default unless legislators extended the funding deadline. The automakers, short by $55 billion to $60 billion, may not be far behind.
The CBO study makes assumptions about defaults that may be optimistic. Just as the steel industry threw its pension obligations on the PBGC, we're watching the airline industry do the same. With Delphi filing for bankruptcy, how long will it be before the automobile industry takes advantage of government pension insurance that you and I will ultimately have to pay for?
The ABC study does make a useful point. Your assumptions can make a large difference in what your expected liabilities are. And I think pension funds may be in danger of over estimating their future returns and under estimating their future liabilities. Let's look at future returns first.
Most corporate pension funds, assume they are going to make 8% compounded returns over the life of their fund. Let's take a typical portfolio mix of 60% stocks and 40% bonds. Let's be generous and assume that ABC is right and that pension plans can get 6% on their bond portfolios. That means they will have to get slightly more than 9% on their stock portfolio in order to have a blended return of 8%. How likely is it that the pension funds will get 9% on their stock portfolios over the next 10 years? The answer is not very.
What Will the Stock Market Return over 10 Years?
In the chart below, Jeremy Grantham breaks down historic P/E ratios into five levels, or quintiles, from level (or quintile) 1, which represents the 20% of years with the cheapest values (lowest P/E ratios) in history right on through the fifth quintile, which represents the 20% of years with the most expensive values.
What kind of returns can you expect 10 years after these periods, on average? Interestingly, the first two quintiles, or cheapest periods, have identical returns: 11 percent. That means when stocks are cheap, you should get 10 percent over the next 10 years. The last, or most expensive period, sees a return over 10 years of zero percent.
Today the price-to-earnings ratio on the S&P 500 is 18.91. That is within the most expensive 20%, but not at the extreme. Even if you want to play games and use very optimistic forward projections, we are still well within that fourth quintile.
Being optimistic, you can make the case that over the next ten years you might be able to see a 4-5% return on your stock portfolio. Being less optimistic, with an eye to history you would project 2% or less.
But for the moment let's be optimistic. A 4% return on stocks and a 6% return on bonds will mean an almost 5% total return for a pension portfolio. What will that 3% difference mean? On a $1 billion portfolio, it would mean an almost $400 million shortfall over 10 years.
And what if we are pessimistic and assume a 2% stock market return and a 5% bond market return? Then we would be looking at a shortfall of over $500 million.
On trillions of dollars in public and private pensions, we are talking massive trillion dollar shortfalls that will have to be made up by either tax-payers or shareholders (out of corporate profits). And every dollar that is not funded now is a dollar that is not earning returns so the effect gets compounded.
What Happens If we Live An Extra Ten Years?
I have been writing in recent weeks about the medical advances that are coming in the next 10-15. There are serious medical practitioners who believe that we will be able to radically slow the aging process within 15 years. Within 10 years, a lot of the diseases that kill us today will no longer be the threat that they are. It is very likely that Alzheimer's, if not cured, will at least be controllable. Certain cancers and some types of heart disease may finally be cured.
Pension plans are simply not prepared for their "younger" retirees to live an extra 10 or 15 years. While they will be healthier, so that medical costs will be somewhat more controlled, retirement benefit assumptions get blown to Hades with an extra 5 or 10 years of life. My research suggests that 5 or 10 years is not just possible, but is likely!
That means many of us will live a lot longer than we planned! While that is good news, it also creates problems for pension funds, especially in the early 2020s when we will see the benefits of the biotech revolution really begin to take shape.
In the mid-80's, there were 112,000 defined benefit plans. Today there are just over 31,000. As more and more executives realize that making commitments for 40 to 50 years into the future is fiscal insanity in a world of accelerating change, we will see the number of defined benefit pension plans drop even more.
But it is not just the fiscal insanity that should lead executives to abandon defined benefit plans. Let's assume you have an employee that is 50 years old and has been working for you for 25 years. It is highly likely that he is going to live to at least 90 if not 100 years old. He is planning on retiring in 10 to 15 years with that nice retirement you promised, indexed to inflation of course.
But the reality is that few companies will be able to fund that plan 30 years from now, let alone 40 or 50. The world is going to be so completely different from what it is today that no 30 year plan will survive intact. We are no longer living in the 1950s or 60s when such long-term planning made sense. It borders on the immoral to allow a worker to retire, thinking they are set for life, when those promises are going to go up in smoke. Or they will be handed over to the PBGC where taxpayers will get the privilege of making those payments.
So, am I slitting my wrist over this? No. Because these nightmare scenarios will ultimately not play out. Corporations will either abandon their defined benefit plans, or at the very least change the nature of the contract. Governments will be forced to change their plans. Things are going to change, because they will have to.
The social contract between generations is going to change throughout the developed world as the needs of an older generation clash with the means of a younger one. Over the next year, I am going to think and write more about this, as I think it will be the defining event of the first part of the century, more so than any other.
And for those of you who do not have to worry about whether your pension will be around in 25 years? You had better plan on saving more than you thought. The good news is that you will probably live longer. You want to make sure you do not live past your savings.
Europe, Canada, New York, London and Amazon
I am in the process of re-writing and re-doing all my websites. We now have new sign-up forms for my accredited investor website for Europe and Canada. If you live in those parts of the world, you can go to www.accreditedinvestor.ws and sign up and get information on various hedge funds and alternative investments. I work with my partners Absolute Return Partners in Europe (they are based in London), and with Pro-Hedge in Toronto, Canada. They will call you and show you the funds we like. If you live in those areas and have already signed up, I would suggest you sign up again, as we have new items and privacy rules which we have enabled, which allows us to be in contact with you.
If you are in the US, and are an accredited investor (basically $1,000,000 or more net worth), you can go to the website and sign up as well. I work with my friends at Altegris Investments to help you find information about hedge funds and other alternative investments. The website explains exactly how we work (it is basically the same for Canada and Europe). (In this regard, I am president of and a registered representative of Millennium Wave Securities, member NASD.)
I am going to be with Jon Sundt and Matt Osborne of Altegris in New York week after next for a conference and then they have talked me into jumping over the pond to London to look at a few funds. But then I am back home and have nothing scheduled for two months, but you know that will change.
I just got back from Detroit this afternoon where I spoke to a very nice group at the local chapter of the World Presidents Organization, and good friend Jerry Wagner of Flexible Plans took me to the home opener of the Detroit Pistons. He has seats on the floor under the basket. Tomorrow, I will go to my second home opener this season where I will see my Dallas Mavericks. My seats aren't quite as good, but almost. Then Sunday, Beau Johnson found some NASCAR tickets for me and my son. The good news is that they are in a suite, so there will be some comfort. I have never been to a NASCAR race, but my son is nuts about cars, so we will have fun watching rednecks chase each other around an oval track (just kidding, guys!). Add some work, a few workouts and the usual chores and it is going to be a busy weekend!
Small confession. I have "only" checked Amazon.com about 10 times today to see what the ranking is. I will probably do so for a few weeks. Just the competitive nature and curiosity. It would be fun to be #1 for a few hours, but knocking off an Oprah book club recommendation from #1 is pretty hard. But I can dream over the weekend. And the weather here (and in Detroit) is/was perfect. Going to be some fun.
And yes, click here and buy Just One Thing now while you are thinking about it. www.amazon.com/justonething.
Your hoping to make it to #1 analyst,