Florence Mortlock - Dignity is a Happy Ending (2006-03-27)

Florence Mortlock - Dignity is a Happy Ending

(2006-03-27) by David John Marotta

Many of our attitudes are learned from the family stories we grow up with. How we handle our finances will influence generations. The life of my grandmother, Florence Mortlock, provided me with many life lessons on finance and financial planning.

My maternal grandmother, Florence Mortlock, was born in Nottingham, England on July 29, 1904 as Florence Bellaby. Her father, Joseph Bellaby was a "Warper", or a tradesman skilled in manufacturing lace. He was recruited by a New York lace company to leave England and come to the United States.

Florence was ill and remained in England when her parents sailed for America. After recovering she made the trip with a caretaker on an ocean liner.

She met and married my grandfather, Donald Mortlock about 1925 in New York City. Neither of my grandparents went to college, but Donald studied finance in the evenings and completed his banking certificate on May 17th, 1929, which is now displayed in our firm’s conference room. He worked for a firm on Wall Street that made a market in several stocks.

A "market maker" was then, and is today a firm that stands ready to buy or sell a particular stock on a regular and continuous basis at a publicly quoted price. One of the stocks my grandfather’s company made a market in was American Can. Originally started in 1901, it was one of the growth stocks of the 1920’s because of the increased public appetite for buying prepared food stored in cans.

My grandfather’s job at the firm was matching up the trading tickets at the end of the day. Back then, a busy day in the market might be over a million shares total and he would have to stay late to reconcile his firm’s transactions. Today transactions in the markets sometimes exceeds 2 billion shares.

Donald was working on Wall Street during the crash of 1929. After the crash, the volume of trading got so low he was laid off. For a few weeks he did not tell my grandmother but continued to leave home pretending to go to work. It was not until she tried to reach him one day by calling the office that she learned he had been fired.

During the depression, life was especially hard for my grandparents. A relative offered them the use of a summer house in the country in Carmel, New York. There, my grandfather tried to make money selling food and other things door-to-door. My grandmother did everything she could to be frugal and make ends meet while raising my mother and my uncle.

A week’s worth of food for the family cost five dollars. One week at the grocery store she went to check out and found that she only had four dollars. Somehow, she had lost a dollar! Putting food back on the shelves, she would remark later in life that lost dollar cost her more than any fluctuations in the markets ever could.

Keeping pace with inflation is especially important for your retirement assets. If you don’t, you will lose your lifestyle, then your independence, and finally your dignity. Retirement planning is about maintaining your lifestyle and having something extra for family and fun.

Had you told my grandmother then that she would need hundreds of thousands of dollars for a comfortable retirement she would have thought you were crazy. Young couples today could need hundreds of millions.

After Donald retired at age 65, they moved to Frankfort, Delaware where he bought a boat and enjoyed fishing. Never one to be idle, my grandfather also founded the Indian River Senior Center in Millsboro. Many of my favorite memories growing up took place during the summers spent at their house near the beach.

My grandfather died in 1981 at age 77. Had you told my grandmother that she would live an additional 22 years she would have again thought you were crazy.

Another conundrum of life came next - my mother died before my grandmother. Soon thereafter, I helped handle my grandmother’s finances. When she did pass away at ninety-nine and a half she was still independent with enough money to last until she was 101.

Planning for a long life is especially important for women. Husbands do a great disservice to their wives if their retirement plan consists of not having enough, spending too much and then dying young. With advances in medicine, living to 100 isn’t as uncommon as it used to be. Your financial plans should take a long life into account. Yes, it is crazy to think that years from now your retirement will cost millions. But, it is smart to do today what will help makes ends meet tomorrow. A good financial planner can help you stay on track and finish with dignity.

from http://www.emarotta.com/article.php?ID=172

VRS: A bird in hand or two in the bush? (2006-03-20)

VRS: A bird in hand or two in the bush?

(2006-03-20) by David John Marotta

I’m retiring this summer with over 30 years’ contributions in my Virginia Retirement System (VRS) account. Because I’ve worked past the full retirement age of 65, I can participate in Partial Lump-Sum Option Payment (PLOP) plan. If I participate in PLOP, I will receive a $29,588 lump sum rolled into a retirement account. If I choose to do that, my monthly VRS income will be reduced by $216. Is this a good choice?

--Decided to Retire

A bird in hand or two hundred in the bush? Analyzing financial options can be a daunting task. The choice of nearly thirty thousand dollars seems much more attractive than a little over two hundred dollars a month. In this case, since the VRS counselors can not offer financial advice, it pays to ask a professional.

At first glance, you might be tempted to analyze the choice this way: $216 per month is about 8.75% a year of $29,588. So if your investments can earn more than 8.75% you should take the lump sum and manage the money yourself. But this answer is too simplistic.

Imagine you take the lump sum and earn exactly 8.75% the first year. You pay yourself $216 a month and think that you have broken even. You have not. If inflation begins running at 5% again you will need to earn $226.80 a month or 9.2% the next year just to keep up with inflation.

Since the VRS payouts are indexed for inflation by the Virginia General Assembly’s annual votes, to match the system would require that you earn 8.75% more than the rate of inflation every year.

A more accurate analysis asks, "If you were to suddenly have an additional $29,588 in investable assets, how much could you withdrawal from this sum without depleting the account before age 100?" Our conservative guidelines say that at age 65 you can withdraw 4.36% of your assets each month and still have money when you are 100 years old.

Therefore, if you had $29,588 in investable assets, you could safely withdraw $1,290 each year (4.36% of $29,588). However, $1,290 a year turns out to be a mere $107 each month.

Giving up $216 each month in exchange for a lump sum of investable cash that has a withdrawal rate of just $107 each month turns out to be a bad deal. It is possible that your investments would do much better than our conservative retirement estimates, but it would still be unwise to take anything more than $107 each month, at least initially.

There is one more rule of thumb that you can use in situations like these. If you are being offered a choice that seems to be outside of the ordinary, it is usually not in your interest to take it. As the old adage says, "If it is too good to be true, it probably is."

In this case, the VRS is offering retirees an immediate cash payment in exchange for a higher standard of living during their retirement. Many people in this situation will probably choose the offer of quick cash. The VRS knows this. Those who do, save the Commonwealth a bundle of cash.

A different personal situation may result in a very different analysis. All of these calculations underscore the importance of seeking professional advice when facing critical financial decisions.

from http://www.emarotta.com/article.php?ID=171

Eighty - Twenty Rule of Asset Allocation (2006-03-13)

Eighty - Twenty Rule of Asset Allocation

(2006-03-13) by David John Marotta

In 1906, Italian economist Vilfredo Pareto created a mathematical formula to describe the unequal distribution of wealth in his country, observing that twenty percent of the people owned eighty percent of the wealth. The 80/20 rule has been recognized by many as a universal principle of life. Its application even wins a place in the logic of asset allocation.

Consider, for example, the mix between stocks and bonds. On average stocks are more volatile but they also have a higher average return. However, there are times when stocks have done poorly. Some people’s investments have still not recovered from the drop in technology stocks from 4-6 years ago. So if you believe in diversification, what is the best mix of stocks and bonds? For the assumptions behind the math to follow I will use US large cap stocks (the S&P 500) and an average bond portfolio (the Lehman Brothers Aggregate Bond Portfolio).

First, let me be quick to say that diversifying solely between the S&P 500 and the Lehman Aggregate Bond Index is a very bad idea. I've written previously that the S&P 500 is a poor investments choice, and in recent years anywhere other than the S&P 500 has beaten the S&P 500 Index. Additionally, there are many alternative investments with higher returns than these two indexes where a portion of our assets should be allocated. Finally, US stocks and bonds are only two of the six asset categories where we recommend investing.

Nevertheless, these two investments provide a good example and paradigm of the rule of thumb that should be used in asset allocation choices between qualified investments.

Consider an asset allocation continuum ranging from 0% Stocks (S&P 500) and 100% Bonds (Lehman Aggregate Index) through 100% Stocks and 0% Bonds. Each asset allocation is rebalanced annually. How would each of these portfolios have done over the past several years in the markets?

A portfolio’s performance is measured two ways: first, the average return it delivers, and second, the average portfolio volatility. Average return is computed by measuring what guaranteed return would have produced the same amount of money had it been compounded each year. Portfolio volatility is measured by measuring the annual standard deviation. We might expect a relatively straight line. The greater the amount of stocks in the portfolio the greater the risk (standard deviation) and the greater the return.

This is not the case.

The curve includes risk and return characteristics that are not on the efficient portfolio horizon.

The efficient frontier was first defined by Harry Markowitz in his Nobel Prize winning work on portfolio theory. An optimal portfolio is the highest returning portfolio for any expected volatility or conversely the portfolio with the lowest volatility for any given return. Only these optimal portfolios are on the efficient frontier. For any portfolio that is not optimal, a portfolio can get a greater or equal return for the same or less volatility.

Notice in our risk return example, the portfolio of 100% stock did not provide the best return, though it did provide the highest volatility. The highest return was with more than 10% bonds. With 20% bond, the return was still higher than an all stock portfolio, but the reduction of volatility was significant.

Similarly, the portfolio of 100% bonds did not provide the least volatility. The lowest volatility was with more than 10% stock. With 20% stocks the volatility was still lower than an all bond portfolio but the return was much higher.

Given the constraint of only these two investment choices, the efficient frontier would be between 10% stocks and 90% stocks. These are the asset allocation mixes which have the lowest volatility and the highest return. Between these extremes, the sweet spot for investing and balancing risk and return is between 20%/80% and 80%/20%.

During a bull market, investors are quick to forget that the markets also go down. Adding bonds to an all-stock portfolio can increase as well as stabilize returns. And some investors that are seeking stability forget that adding small amounts of more volatile investments can actually reduce volatility. Adding stocks to an all-bond portfolio can stabilize as well as increase returns.

Asset allocation becomes even more complex as additional investment choices are added to the mix. Some investment choices add neither lower risk nor higher return to a portfolio. These investment choices are best eliminated from your portfolio. Other choices may be able to reduce risk and increase return by inclusion in your asset allocation.

Turbulent years are coming as certain as they have come in the past. The 80/20 equation of life is the result of personal choices. The financial successful save consistently, diversity wisely and spend frugally.

from http://www.emarotta.com/article.php?ID=170

Dear Ready to Retire (2006-03-06)

Dear Ready to Retire

(2006-03-06) by David John Marotta

Dear Marotta Asset Management,
My wife and I are hoping to retire soon. What percentage of our investments can we withdraw each year? And, do you recommend a high-yield investment portfolio to create the necessary cash flow during retirement?
--Ready to Retire

Dear Ready to Retire,

Studies suggest that for people retiring between the ages of 62-65, withdrawal rates of 4% of their assets are safe, but 5% significantly increase the likelihood of running out of money during your lifetime. Unfortunately, those studies are not very helpful for real financial planning questions.

Not everyone is between 62 and 65. Nor do everyone’s withdrawal choices move in neat intervals between four and five percent. Real clients want to know the specifics: "What percentage of my assets can I safely take out this year and still be able to provide for my spouse and me each year for the rest of our lives?"

As a result, we’ve developed safe withdrawal rates for ages 0 to 100. Our rates are based on age-appropriate asset allocation mixes and assume that withdrawal rates will go up each year to meet the needs of inflation. Withdrawal rates should also be conservative enough to allow for constant increases even when the markets have a poor year.

Reproduced in this table are some of the results:

Age:	Withdrawal Rate
62:	4.11%
65:	4.36%
70:	4.77%
75:	5.35%
80:	6.22%
85:	7.66%
90:	10.42%
95:	17.86%

To illustrate this point, let’s take a real-world example of the Wahoos. Wally and Wilma Wahoo are 75 with a $1 million portfolio. If they withdraw $53,500 or 5.35% from their account at the beginning of the year, and their portfolio grows by or 9% over the next 12 months, then at the end of the year their account would be worth $1M -$53,500 = $946,500 + 9% growth = $1,031,685.

Next year, when they are 76 years old, their new withdrawal rate according to our table is 5.49%--slightly more. Since their account value and withdrawal rate are now larger they would get a raise. Following this plan, at the beginning of year two they would receive a 5.9% raise or $3,139 more for the year. (5.49% of $1,031,685 = $56,639 for the year.)

Since their monthly “allowance” increased $262, their standard of living can keep up with inflation and then some.

Many people make the mistake during retirement of thinking that they need to have mostly interest-paying and dividend-paying investments to generate cash for withdrawals. This is incorrect.

People often have an unwarranted fear that they can’t "touch the principle" and therefore, should not sell stock to generate cash. For retirement income, it doesn’t matter if you receive $50,000 in interest and dividends or if you receive $50,000 by selling assets that realized a capital gain. Either way, $50,000 is $50,000.

Let’s consider an example. If 100 shares of a stock double in value and then, the stock splits and you sell half your shares, have you "touched the principle?" The truth is, you are left with 100 shares of the exact same stock at the exact same value, plus a pile of cash. There is no difference between this case and getting paid that pile of cash in dividends.

Putting everything in one type of investment is usually more volatile than diversification. Therefore, we do not recommend an exclusively interest and dividend-paying portfolio. But, having said that, I must add that good dividend-paying stocks, sometimes called "value" stocks, get a higher return and at the same time are less volatile than "growth" stocks. We would recommend overweighting value stocks, even in a non-retirement portfolio.

Retirement plans should be reviewed annually. Doing a projection every year will help you determine how much you should be saving, or if you are retired, how much you can spend. A handy goal to aim for is to save 24 times your salary by the time you retire.

Sincerely,

David John Marotta

from http://www.emarotta.com/article.php?ID=169

The French Kiss of Death (2006-02-27)

The French Kiss of Death

(2006-02-27) by David John Marotta

Over the past decade, the French economy has been given the kiss of death by the burden of socialist "feel-good" labor laws. The French government’s intentions were good, but cumulatively they have poisoned French entrepreneurial competitiveness and paralyzed their economic growth.

At the root of France’s lethargy are heavy governmental mandates. Soon after his 2005 appointment as Prime Minister, Dominique de Villepin summed up this fear of capitalism by imploring the French not to "resign ourselves to making our continent a vast free-trade area, governed by the rules of competition."

French unemployment rates have exceeded 8% for twenty years. Employment regulations intended to increase employment and job security have had the exact opposite effect.

France pioneered the 35-hour workweek. The idea was to limit the number of hours per worker and thus, force companies to hire more employees. Unemployment should have disappeared overnight, but it only got worse. By law, companies must also grant 35 days of paid vacation each year.

With unemployment increasing, the French government tried to make it more difficult to fire employees. Now, firms who dismiss more than 10 employees must pay up to 9 months of severance pay and pick up the tab for job search costs and reclassification training.

A 2005 study published by the World Bank measured the business-friendliness of 155 countries around the world. France finished a sad 142nd of 155 countries due to the overall legal protections regulating the hiring and firing of workers.

The result of French labor laws has been to make doing business in France with French employees very unattractive. Even French companies have adapted by outsourcing work to lower cost foreign companies in order to remain competitive.

After binding companies with firing restrictions and paralyzing the number of hours their employees can work, French law then drains 43% of company gross profits in taxes to fund employee health care, education, and retirement. France shouldn’t be surprised at 23% youth unemployment or 1.5% GDP growth. France should be surprised the economy can still twitch at all.

The United States remains in much better health because it is free of these socialist tendencies. Most job growth in America has been among small businesses with fewer than 50 employees. That should come as no surprise, since companies with 50 or fewer workers are not subject to federal employment regulations.

But the United States is not automatically exempt from misguided legislation. The recent Maryland law, which forces large companies (i.e. Wal-Mart) to contribute 8% of their gross profit for employee health benefits, is a venomous bite that will result ultimately in higher unemployment. Currently, more than 30 other state legislatures are preparing similar stings. However, labor laws camouflaged as 'employee protection' usually result in unemployment.

After requiring 8% of profits to fund employee health care, why not force companies to spend 3% on employee education? Everyone should have 35 paid vacation days. Factories should fund public transportation so their workers can get to and from work. Every worker should have life insurance. Pension benefits should include long-term care insurance. Employers should provide meals for shift workers or stipends for a family’s groceries. Sick leave should be provided for those who need to take their pets to the vet.

Since the Maryland ruling, Wal-Mart has not resumed work on a large distribution center slated for Somerset County, Maryland –an area posting higher unemployment than the rest of the state. The real losers of Maryland’s business attacks will be future residents who can’t find profitable companies to employ them.

In January, the French government released its new employment plan in response to the rioting French youths who demanded a government fix to their high unemployment rates and poor public housing. In a decidedly un-French move, the new plan promises to create jobs by lightening up on the 'employee protection laws' –which got them in this mess in the first place.

We can learn from the French that more government is the kiss of death, and real wealth is built on economic freedom.

from http://www.emarotta.com/article.php?ID=168