Social Security: Could offering lump sums help?

on March 17, 2016 No comments

It is certainly not a secret that the health and longevity of Social Security is at risk.  In fact, the Social Security Administration has the information available under their Fast Facts and Figures.  Their analysis shows that Social Security is no longer solvent as of 2034, which is now less than 20 years away.  For so many of us, we are contributing today to provide retiree benefits, and we may not have the opportunity to receive the level of benefit available today.

Social Security Solvency

Estimated net outflow of capital from Social Security as a % of taxable payroll – SOURCE: 2015 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, Table IV.B1 (intermediate assumptions).

One of the biggest issues facing Social Security is a demographics problem.  In the mid 1950’s there were more than 8 workers paying into Social Security per beneficiary.  Today there are fewer than 3 workers paying into Social Security per beneficiary.  This is only expected to decline in the coming years as the Baby Boomer generation continues to enter retirement, and they begin initiating retirement benefits.

Social Security's Demographic Challenge

Ratio of covered workers to Social Security beneficiaries – SOURCE: 2015 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, Table IV.B3 (intermediate assumptions).

 

In Washington there is always debate about the best approach to get Social Security back on track, but there always seems to be only band aids to get it to the next decision that has to be made.  The best example is the most recent legislation in the Bipartisan Budget Act.  In Section 833 of the legislation, there is a provision regarding the funding of Social Security’s Disability Insurance.  The provision was established to prevent the disability insurance fund from being depleted at the end of 2016.  It is now anticipated that the fund will be depleted in 2022.  The provision changed the amount of tax revenue directed into the disability fund.  Of course the Social Security Insurance fund as a result will receive less money.  This is a great example of a short term band aid rather than a solution.

Now, I will certainly admit that the daunting task of fixing Social Security is not something that is easy.  In addition to being extremely complicated, it is also a political nightmare.  There has been research that indicates simply increasing the full retirement age or early retirement age does not give the long term impact needed.  It only delays for a modest time the inevitable.  Fortunately, there is research being done that will hopefully contribute to thinking outside the box in terms of options for reform. 

At the University of Pennsylvania, Olivia S. Mitchell and a group of other authors from St. John’s University and Goethe University in Frankfurt Germany recently released a paper titled, “The Potential Effect of Offering Lump Sums in the Social Security Program” in Issue Brief Volume 3, Number 9.

In their research, they were interested in the impact of offering a lump sum amount of money if individuals delayed retirement benefits.  I believe we all recognize that for Social Security to remain solvent and be available in the future, reform is required that either increases the input of capital or reduces the rate of draw from the capital available.

Well if new retirees delay benefits, there is a strong likelihood that they will also continue working.  By both delaying benefits and continuing to work, they have reduced the benefit payments out of Social Security and also added capital to the fund while working longer.  In their research, the desire to receive the lump sum was motivation to delay their retirement age.  In addition to the delay for filing by offering the lump sum, there is a possibility that the lump sum could be calculated to help increase the longevity of Social Security as well.  This could be the outside the box type of thinking that helps repair Social Security for the long term.

Hopefully, we continue to see interest in the research community to find potential ways to increase the longevity of the Social Security for future generations.

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Jeffrey MillerSocial Security: Could offering lump sums help?

Market Volatility – Four Thoughts and Practices

on March 4, 2016 No comments

       If I told you today that the Dow Jones went down 500 points, we’d all say, “Wow, what the heck happened?” And for some of us, market volatility might cause more trepidation than optimism.  Well what if I told you instead the S&P dropped 59 points in one day.  How would you respond?  Maybe, “Who gives a rip? It’s 59 points!”  Does the market sound volatile in that scenario?  Let’s talk a little on this phenomenon called behavioral finance (see video)

If you do the math, both of those numbers equals 3% of their respective indexes below…
500 points/16500 points in Dow Jones Index (DJIA)= 0.03 x 100% = 3% drop
and…  59 points/ 1950 points in the Standard & Poor’s Index (S&P) =  0.03 x 100% = 3% drop

       1st- Understand the implication of the numbers.  What’s the number behind the number really mean?   The numbers look bigger in one index, but the percentages are the same in both indexes when it comes to measuring market volatility.  

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Figure 1. – Market volatility and correlation of stocks to historical events. (Source: Business Insider)

         Above (fig. 1) is a good example of late 2012 with a backward looking view of the daily market volatility.  It shows a 3-month moving average in the Dow over 90 years with every major event you can imagine.  To be honest, a 3% swing in one day is somewhat significant whether it’s negative or positive.   There have been times historically where the indexes have fallen in a matter of days and sometimes weeks of anywhere from -10% or -20%.  When we see on the news bold headlines-  DOW FREEFALLS 500 POINTS   we can panic out of fear.  We’ve been trained as Pavlovian dogs the past few decades to cower in fear more than to invest with optimism.   This is where we can sometimes show our true colors and understanding of the stock market and investing- in effect, this causes more market volatility.   We forget about the long-term because we’re suffocated in the short-term with no deeper understanding of how to interpret the numbers, so study what the numbers really mean. 

 

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Figure 2- Media headlines and the relation to market volatility (Source: Federal Reserve)

 

 

 

 

 

 

 

 

 

 

 

 

        2nd-  Understand the news media’s motives.  I’ll try to be short with this thought.  Be sure to apply the statement of ‘don’t believe the hype’ with your financial lens.  Whether it’s FOX, CNN, CNBC, MTV, or HGTV – whoever- they all have their motives to get as many eyes and ears to get revenues by selling Today (fig. 2).  I believe it’s harder today to aim at avoiding bias and look at the facts objectively.  The media inundates us 24/7, and mirroring the negative news becomes a self-fulfilling prophecy and amplifies market volatility. The Nazi Propaganda Minister Joseph Goebbels once said, “If you tell a lie big enough and keep repeating it, people will eventually come to believe it.”   We’re no longer concerned much about yesterday or five or ten years ago because we’ve forgotten History (past lessons in our country we now consider boring).  Instead of watching a T.V. show that doesn’t have any understanding of Economics, Finance- again throw History in there too- listen to subject matter experts, and how that relates to your day to day financial life and decision making.  Read more books with subjects on investing and dialogue with trustworthy experts.  None of this sounds sexy.  It’s boring at best, but vital for investing.  

 

 

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Figure 3- Short term market volatility should dictate longer term financial goals. (Source: Slideplayer)

         3rd-  Understand your goals both short, mid, and long-term.  It’s about you and your financial goals!  Some of us wish we had long term goals.  Some of us don’t know how to plan for the next month.  It can be intimidating and discouraging.  Start thinking today and take baby steps.  What about that $10-15k that you have sitting in that brokerage or bank account?  Ask yourself, how soon will I need that money?  Is it an emergency fund for the next 2-3 months (fig. 3) to protect from a possible shortage in pay or job loss?   What about that tax deferred 401k retirement plan that has $20k sitting in cash the past 10 years?  Do you have a realistic plan?  Do you understand the power of tax-deferred compounding growth of 4-7% for the next 20, 30, 40 years of your life?  

       If you are starting at ground zero, a good start may be a monthly investing goal of $200 in an investment account with low expense ETFs or no-load mutual funds.  This costs very little, and is a simple way of priming the pump.  For those more risk averse, this also reduces risk when you spread investments out over a time period of months or years versus a lump sum of money at one point in time.  Or combine both of these strategies.  I have no regrets when I started investing at age 18, and it’s taught me huge lessons.  This also makes a huge difference if you discipline yourself and commit contributing to a tax-deductible, tax-deferred retirement bucket (aka IRA or 401k).  Retirement accounts are designed for your long-term strategy.  So, if you plan on using the money in the next 6-12 months then a non-retirement account is better (i.e. bank or brokerage account) because it will likely be harder to get a return you’re looking to make.   Taking risks with short-term money in stocks is especially harder in the volatile and somewhat unpredictable markets currently and over the past year.  On a different note, in the intermediate term, your strategy may make more sense in a brokerage account if you know this investment will be needed in the next 2-5 years.  Tax implications will need to be considered and you may need a tax professional to thoughtfully guide you along the way.

 

 

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Figure 4- Historical events that amplified market volatility (Sources: Wall Street Journal  and Quora)

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       Last, and maybe the most important- understand the risk YOU are taking.  Know yourself by going over a risk tolerance review as one example.  Many young investors in their 20’s and 30’s, may be a little more hesitant to just throw their hard earned money 100% into the stock market after seeing and maybe experiencing the 2008 crash.  If your psyche didn’t get to you and had a more disciplined approach you would have been better off.  Your investment in an S&P index fund would have paid off and accumulated over 153%% in a matter of 7 years from March 2009 to March 2016 if you held on- this is an aggressive tolerance and more long-term strategy.  Further, if you reinvested dividends on that S&P index, the returns would have made 191%.  So, if you’re looking to be in investments for 5-10+ years, create a longer term plan and not the media hype plan.  If we’d look at the images of history (fig. 4), it would teach us about investing when you look at events which riveted stock markets like the crash of 1987 or 2008, the Vietnam or Gulf Wars, the tech bust in the early 2000’s along with the event of 9/11. 

 When it comes to risk, you want to ask yourself if you’re comfortable with the chance of loss or growth of principle of 5, 10, 20 or 30% in any given year? How did you respond and how was your attitude during that low?  Your overall rate of return expectation is heavily tied to whether you are conservative with risk (Tortoise), moderate risk (what I call Tare or Hortoise), or aggressive risk (Hare).   Historically, being in a stock heavy or bond heavy portfolio over the past 5, 10, 15, or 20 years for that matter using proper asset allocation would have paid off.  It’s the proverbial “not all eggs in one basket”.   The strategy of sitting in cash or getting in all gold, or bitcoins or any one asset class for that matter increases significant investment risk.  Consider a diversified asset allocation thru your retirement plan no matter how conservative or aggressive you may be.   Have an actual relationship with an investment professional to meet, and re-balance your portfolio based on your evolving personal financial goals, risk temperament, and forward looking market expectations.  So remember, you only get in returns what you personally are willing to risk, and most of that is in the long, not short-term lens of investing.   Welcome to what we define in the financial services industry as Behavioral Finance. 

We hope this article was insightful.  If you have any questions or comments, we’d appreciate your comments.  Always feel free to visit us or our website at www.couragemiller.com

 

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Jeffrey MillerMarket Volatility – Four Thoughts and Practices