Tuesday, January 12, 2010

The Myth of Retirement

Recently I had a conversation with a colleague. It originated as I shared with him an article regarding the current state of the economy written by renown money manager. His response, while astute and thought provoking, was said from the wrong perspective. He asked, “what am I going to do with this information…is it going to help me make money?” He went on to explain to me his retirement position and of those of his next of kin whom he indirectly advises. He seemed anxious to jump into the stock market, given that it’s increased about 40% in a little less than a year. He is making close to zero simply sitting on cash and feels left behind in light of the big advance by the stock market. But therein lays the heart of the problem: the need to do something…the need to pick up nickels in front of an oncoming train.

Let me give you an example of what I am talking about. Assume you were able to buy an index of the market (S&P 500) in 2002. Assume you bought at a low of that year (~ 800). If you held the position for about 6 years (and were smart enough to close it), the value increased to ~ 1,500, or about 11% annualized return, just before the market crashed in 2008. Not bad in terms of simply parking your money at the bank at 2-3%. But lo and behold, you are not like the minority and kept the position and saw it dwindle to about 680 (in March 2009). At that time you had accumulated a negative return. Parking your money at the bank would have been a much better investment. Consider the present perceived value of the market, 1,130; even at this point, your annualized return (from the starting point of 2002) is 4.7%, a meager amount if you take into account risk and price inflation.

The whole point of this back-of-the-envelope exercise is to demonstrate how “the best laid plans of mice and men often go awry.” People will make investment decision for their retirement believing the value of the currency (and portfolio) will increase. We are living at a time that nothing can be taken for granted. For a large majority of people (80%, using Pareto’s Law) sooner or later they will come to grips that they have been living in fantasy island with regard to their retirement plans. The only sensible retirement plan that has worked throughout human history is to have no retirement plan—unless, of course, you are an individual physically unable to work. The reality of our times is that those who feel they are in firm ground when it comes to their investment portfolio, yet unaware (or disbelieve) of the risks that lurk in the economy today, will be the ones most hurt—not only because they will have lost lots of money, but because their pride and sense of accomplishment will have been reduce even more.

My colleague is emblematic of a belief of many in our generation: a sound portfolio will save you. I asked my colleague what he had invested. His response: a mix of equity and fixed-income mutual fund. We are heading into a storm where money will fail and his portfolio will dwindle to irrelevance in value in his lifetime. What is tragic and sad about it is that people like him don’t (or refuse to) see it coming.

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