To our children and grand children:


These can be good financial times, not bad times!


The stock market is falling.  It may be bad for many retirees and those that will lose their jobs as brokers or from bankruptcies but not for many people—IF


·         their investments have been widely diversified, and

·         they have set a tolerance band for reallocating their investments.


Over my almost fifty years of investing, I have seen markets drop many times.  In my first fifteen years I learned the lessons the hard way—by losing money.  I followed the market.  When it got high, I bought.  When it fell precipitously, I sold.  Ugggh!  I was supposed to do just the opposite.


Eventually, I found a way to do better.  I set upper and lower limits to the amount of stock (including stock funds) that I would hold at various ages.  The formula was simple:  I would not let the stock as a percent of my holdings get below 100 minus my age.  That was the bottom side.  Then I set a limit for the top side, namely, 110 minus my age.  So, at age 40 (about when I first started this) my stock allocations were between 60% and 70% of my investments.


After a while I added real estate investments to my portfolio.  I count the equity (price less debt) as a “stock” because, after all, stock is equity as well.  I did not count the equity in my home as an investment because I reasoned that I would always need a home.  Besides, my home was quite modest.


Now, at 75, my equity limits are much lower:  between 25% and 35% of my investments using the very same formula.  The remainder of my holdings are in bonds and money markets.  Using these limits over all of these years has given me a portfolio return that is higher than if I had steadfastly held to an equity limit of 105 minus my age.  That’s because I bought stock when prices were low and sold them when prices were high.  I described the performance differences in my book, “Getting Started in a Financially Secure Retirement.”


Not long ago I was on a radio talk show in New England.  I talked about my allocation limits.  The talk show host said I was old fashioned and dismissed my conservatism.  He felt, as do many, that even retirees should have much larger stock allocations.  I thought to myself, “He’ll learn!”


I can’t see the future any better than anyone else, so my conservative bent could be wrong.  I base my stance now on something very simple indeed.  That’s the deplorable decline in savings rates over the past 20 years and the almost inevitable changes in demographics.  These embody the effects of overdone consumerism, excessive debt and the forthcoming reduction in the ratio of workers to those who will be retired or trying to retire.


In “Getting Started in a Financially Secure Retirement” I show that it will be impossible for the average person to save enough over the next 20 years to be comparable to what the 9% historical savings rate yielded.  We would have to equal the kind of savings we had in World War II when virtually everything was rationed, there was nothing on the store shelves to buy, everyone worked, and buying savings bonds was the politically correct thing to do.


My simple analysis of necessary savings rates does not count the great reduction in the percentage of workers who will get pensions over the past 20 years.  The only major segment of our society where the pension benefits are increasing is the government sector which not only is increasing as a percent of our labor force but also has cost-of-living-adjusted (COLA) pensions that are backed by a sovereign power with the ability to tax.


On the demographics side, the ratio of workers to those over 65 will go from 3 now to 2 in the next few decades.  Again, the effects are very simple to visualize.  That part of our taxes (the largest part) used to support the elderly will have to increase 50% for working folks.  That by itself will be debilitating for the economy unless government benefits are trimmed with a meat ax.


On the debt side, by the end of this year every man, woman and child will have a federal debt obligation of over $180,000.  This includes only the national debt, Social Security and Medicare.  It does not include mortgage and personal debts nor state debts and unfunded obligations.  A family of four could easily have an equivalent debt approaching $1 million including mortgage and personal debt obligations.  At an average interest rate of 5%, that would be equivalent to an annual cost of $50,000, just to pay the interest without retiring any of the debt.  The median family now earns about $70,000.  That leaves about $20,000 for living expenses, state taxes and retirement savings.


Of course that assumes that income and taxes are evenly distributed.  Since 40% of workers pay no income taxes at all, the burden will be 67% more on those who do pay income tax.


So, what do I think will happen?  I believe that not only will income taxes go way up, so will every other form of taxes go up including ones that haven’t yet been invented.  As has already happened in several places in Europe, the government will also have to reduce benefits.


Further adding to the problem will be increased inflation.  That’s because I believe that the demands for higher wages will increase as will the price for goods both because of higher industrial taxes and higher labor rates.  Productivity growth will slow because of increased demand for U.S. labor content.  Finally, the feds will silently applaud inflation growth because it will, as always, reduce the apparent size of the national debt relative to GDP.


So why then wouldn’t I advocate holding any stock if the economic future is so bleak?   The reason is that stock represents owning something tangible that will increase eventually with inflation.  The same is true of investment real estate.  If you have been following my past recommendations, you might be buying stock now, not selling it.


Do I think that things can get worse?  Absolutely.  That’s why I do things incrementally.  When in doubt I go half way.  That gives me an opportunity to talk about the part that did well and ignore the part that didn’t.  After all, isn’t that the way the finance industry promotes its performance achievements?  (Smile!).


Caution:  I can’t see the future any better than anyone else.  But I can testify that (1) if you don’t save anything, you won’t have any savings, (2) that regular savings grow faster because of reverse-dollar-cost-averaging, (3) that diversifying investments helps savings growth over the long-term, and (4) that allocation control really pays.

Love, Dad