Your Age and How Much Saved: A Quick Calculation

Your Capital To Income Ratio is a quick tool to help you determine whether you are on track with your retirement savings. My experience, as a practicing financial planner, is that most people are not saving enough to maintain their standard of living in retirement.

This post is copied from "The White Coat Investor"  blog: http://whitecoatinvestor.com/

"The Capital to Income Ratio is the most important ratio discussed in Charles Farrell’s Your Money Ratios.  It’s the ratio of your retirement stash divided by your current income.  If your income has recently increased significantly, average your last four years of income.  If you have a sporadically working spouse, don’t count his or her income.  If your spouse works, use both incomes, and average your ages.  The chart below can be used to see if you’re “on track” for retirement.

Age	Capital to Income Ratio
25	0.1
30	0.6
35	1.4
40	2.4
45	3.7
50	5.2
55	7.1
60	9.4
65	12

Per Mr. Farrell’s calculations, maintaining these ratios will allow you to retire on 60% of your income (plus social security) at age 65.

For example, a 45 year old doctor making $200,000 a year should have $740,000 in retirement/savings accounts.  Try calculating your ratio out and see how you’re doing.  I’m right on track, which is reassuring, since I don’t actually need my investments to provide 60% of my current income as discussed here

He provides two other charts in his book, which he labels the “silver medal” chart and the “bronze medal” chart, which allow for you to retire on 50% of your income at age 65 and at age 70 respectively.  Chart out your ratio on these charts and see where you stack up:

Age	60% at 65	50% at 65	50% at 70
25	0.1	0.1	0.1
30	0.6	0.5	0.45
35	1.4	1.25	1
40	2.4	2	1.6
45	3.7	3.1	2.5
50	5.2	4.5	3.5
55	7.1	6.1	4.8
60	9.4	8.1	6.5
65	12	10	8.2
70			10

Using these charts you can see what you’re on track for. If you’re way ahead of where you need to be, early retirement might be an option for you. If you’re behind, better start saving more."

Invest Consistently: Sound Advice.

Sound advice from James P. O'Shaughnessy, the author of the best selling What Works on Wall Street:

"Consistency is the hallmark of great investors and it is what separates them from everyone else. If you use even a mediocre strategy consistently, you'll beat almost all investors who jump in and out of the market, change tactics in midstream and forever second-guess their decisions.

Look at the S&P 500. It is a simple strategy that buys large- capitalization stocks. Yet this one-factor, rather mediocre strategy still manages to beat 70% of all actively managed funds because it never leaves its strategy. Realistically consider your risk tolerance, plan your path and then stick to it. You may have fewer stories to tell at parties, but you'll be among the most successful long-term investors. Successful investing isn't alchemy; it's a simple matter of consistently using time-tested strategies and letting compounding work its magic."

Excerpted from James P. O'Shaughnessy's "Advisors Bookshelf" column in December 9 edition of Investment News.

Hayek, spontaneous order and index funds

If I can use a picture of Salma to get one to click on this post and read a little about Friedrich's ideas, I have achieved a small victory in educating the masses. 


This is a re-post in a new package.

"in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process… will hardly ever be fully known or measurable."

The above quote is from the 1972 Nobel prize lecture of Austrian economist Friedrich Hayek who wrote brilliant works that explained the errors of fascism and socialism. He taught that the modern economy has too many variables for one person, or organization, to efficiently allocate its resources. Hayek argued that the price system does a better job of allocating resources than a government controlled system. Hayek's observations are part of his reflections on spontaneous order - which is the idea that order comes out of chaos when many self interested individuals are involved. This idea is played out in many areas. A recent example of spontaneous order is the open architecture software - Linux, which is written by programmers from all over the world who, in their spare time, add to the code. Linux now operates some of the fastest computers in the world and is the operating systems that runs many devices that we use in our daily life.

So how does this apply to investing?

The investing world is divided by those that believe they can predict economic and investment trends - the active managers, they believe they can predict which stocks to pick for your portfolio or mutual fund. Then there are those that believe that the stock market is too complex to make those decisions accurately on a consistent basis (the indexers). The indexers argue that the collective wisdom of all the investors in the world will average out to the best answer. The indexers, one could say, are Hayekian in their thinking. They would argue that if Wal Mart makes up 2% of the stock market, then an individual investor should own 2% of Wal Mart.

What is the collective wisdom of all investors in the investing world? Answer: index funds.

What is the record of index funds? Answer: Over time, they outperform active managers. Yes, year to year some active managers outperform the average. But it is not the same ones on a regular basis.

Spontaneous order seems to play out in stock funds. It explains why index funds outperform active managers. The collective wisdom of the many results in better investment performance than that of one or a few.

What does this mean for the average investor. It means that the best course of action has been to hold a well diversified, risk appropriate portfolio of the global stock and bond market, fund it with index funds, and rebalance annually.

For an analogous column, see Russ Roberts's 2004 Business Week column : "The Bagel and the Index Fund,"

http://www.businessweek.com/bwdaily/dnflash/jan2004/nf20040120_6180.htm

I recommend Russ Roberts's podcast: Econtalk, his blog: Cafe Hayek, and his books: "The Choice", "The invisible Heart", and "The Price of Everything."

Roberts is a professor of Economics at George Mason University

In another related article, see Jason Zweig's January 8, 2011 Wall Street Journal Column, in which he also cites Hayek in his explanation on why forecasters rarely get forecasts correct:

http://online.wsj.com/article/SB10001424052748703675904576064320900295678.html?mod=ITP_businessandfinan

Is There A Choice???

I read a short article this morning on saving for retirement. The article references a 35 year old saving for retirement and it explored his saving options: saving in a 60% stock portfolio vs. 80%  in stocks. And I thought: as we sit in an environment where the economy is shaky, personal and government debts are high,  the media and some investing advisers telling people "this time its different." What is one to do? Should one invest in the stock market? Is this advice still valid?

I believe it is.

I think one has to invest at some level in the global stock market. Your other option is keep your nest egg in cash or in a bank- earning nothing and actually losing value through inflation - that is a risk concern in itself..
But if capitalism,  and thus our economy implodes, then it wont matter if you held cash - banks will have failed and your Federal Reserve Note will be worthless.
So, one needs to take the leap of faith: that, over the long haul, capital markets will provide positive returns that exceed inflation. If they dont, as I said, it means that our economy has collapsed and then nothing you have has value.

I know, someone is sure to mention gold. But when the economic apocalypse occurs, one can take their gold too Wal Mart, unfortunately nobody will be there to exchange your gold for goods and the shelves will have been looted dry. As the economist Nouriel Roubin has said, forget gold, one will want Spam when the economic apocalypse arrives.

I maintain the old rules hold: one must invest in a mix of cash, bonds, stocks that are appropriate for the investors risk tolerance and time horizons.

A final thought: as many have rushed into US Treasury Bonds, ask yourself, who generally manages their finances better: governments or the majority of public companies? Congress or Wal Mart, GE, Apple, Microsoft etc?

I referenced this idea in a prior post: "REM, Pascals Wager and The Stock Market"

Survival Bias-Another Great Reason to Invest in Index Funds

This is a re-post from one of my favorite investing bloggers - "The White Coat Investor" - a young physician who decided to take investing into his own hands. He is very similar to the brilliant William Bernstein MD: author of "The Four Pillars of Investing"

In this post, Rick Ferri's new book is referenced. I highly recommend Ferri's books and blogs.

Survival Bias-Another Great Reason to Invest in Index Funds

Posted on November 16, 2011 by White Coat Investor

Survival Bias-Another Great Reason to Invest in Index Funds

Survival bias is what happens when some of the data that should be in a data set is deleted. The “surviving” data paints the picture as being better than it actually is. This is a real concern when you look at actively managed mutual funds.  Rick Ferri, in his new book, The Power of Passive Investing, displays this chart (used with permission.)

Figure 1: Twenty Years of Active Equity Funds (based on 100 funds)

If you do not account for survival bias, YOU’RE MISSING HALF THE DATA.  That’s such a huge effect.  Over 20 years, it appears that 17/50 (34%) of actively managed funds significantly outperformed their respective index.  but if you look at ALL the data, that number quickly shrinks to 17/100 (17%).  More depressingly, if you only consider those that significantly outperformed the index, that number is down to 6%.  I don’t know about you, but I’m humble enough to realize that the odds of me picking the 1 fund out of 20 that will significantly outperform is too low to justify the activity.  I’d be doing well to pick one that survived for 20 years.

There was another study done in 2006 by Savant Capital Management looking at the Morningstar database.  Basically, they inserted all the now-extinct funds back into the database to determine how much worse that would make the average actively managed fund look compared to the indexes.  They examined the time period 1995-2004 and found that survivor bias accounted for an additional performance gap of 1.3% per year.  Add that on to the already significant performance gap (heavily influenced by additional costs) and you have a real uphill battle for active managers.  1.3% a year is huge.  Consider two portfolios, one which grows at 4.7% real a year and one that grows at 6% real a year.  If you add $30K to the portfolio each year for 30 years, the one growing at 6%/year is worth 25% more, or nearly a half million bucks.  I don’t know about you, but I can think of a lot of things I could do with an extra half mil.