Thoughts on Pensions and Retirement
John Mauldin
Just One Thing
Can I Ask a Personal Favor?
Corporate Pensions Down $450 Billion and Counting
What Will the Stock Market Return over 10 Years?
What Happens If we Live An Extra Ten Years?
Europe, Canada, New York, London and Amazon
How bad is the pension fund issue. Is it a crisis as the Pension Benefit
Guaranty Corporation (PBGC) claims? Or is the American Benefits Council right
when they say the problems are blown out of proportion? And depending on your
assumptions, they could both be right. Examining this debate will provide a
useful springboard as we examine retirement issues you may be facing.
But first, last week I promised a special announcement. Ready to ship and in a
bookstore near you is my new book called Just One Thing. Some of you may have
received an email yesterday about the book, and a lot of you ordered, because it
is now #4 on Amazon in less than 24 hours! Permit me to make a few personal
observations about the book and the publishing process.
With my last book, Bull's Eye Investing, I announced two years in advance I was
writing it, and kept postponing the publication date. My "book-in-progress" I
called it, but at times there seemed to be little progress, which did frustrate
more than a few of my readers. This time around, we decided to wait until the
books had been shipped to the bookstores to make the announcement.
Bull's Eye Investing did very well, making the New York Times bestseller list
and a number of other bests-selling lists. The reviews were better than I could
have hoped. It is still selling at a steady pace. Thanks to everyone who made
that possible by buying the book. I am truly grateful.
So, it is natural that my editor at Wiley, Debra Englander, wanted me to do
another book, and "By the way, what time this year can I have it?" But I gotta
tell you, I just don't have another almost 500 page book with hundreds of
footnotes and 20 pages of bibliography in me. Not this year, at any rate.
So I did something even better. I got 11 of my friends to write chapters. "Just
One Thing," I told them. "Give me the one Best Idea you have learned about
investing - the one thing you are personally most passionate about - that you
want to pass on to your kids."
I am proud of this book, gentle reader. There are 12 great chapters from some of
the smartest minds I know. One of the great things about working in my world is
that I get to run around with some very smart, very successful people, who also
happen to be very good investors. I get to pick their brains and learn from the
best. If you could get a chance to sit down with Richard Russell or a Gartman or
Kessler or Gilder (or Shilling or Arnott or the rest of the writers of my new
book) most of us would leap at the chance. What is one idea worth if it helps us
become better investors, or saves us the pain of losses?
The authors of these chapters have all learned a lot along the way. "Why not," I
thought, "ask them to share the wealth of their wisdom?" And so I did. The rules
of the book were pretty few. I told them to write me a chapter on a subject they
had expertise in and thought was one of the special insights they had picked up
in their time. I gave them no minimum or maximum word length. Make the chapter
long enough to cover the topic. As you will notice, some chapters are quite
short and others are feature length.
"Make it readable and understandable to the average person," I told them.
"Nothing is more frustrating to me than a great idea you can't understand. I
want something you are passionate about. Make it something that will give my
readers an 'aha' moment. It will probably be something you have worked on for a
long time. Maybe you already have the basic outline or material done. Just share
it with us."
Now, I could guess what a few of them would write about before I asked. Mark
Finn was going to write about the problems of past performance. He is absolutely
brilliant on that (and a lot of other things), which is why he gets big
institutions to keep coming back for his consulting. And you knew that Dennis
Gartman would write on his Rules of Trading. Gartman has forgotten more about
trading than most of us will ever know. Which, he would tell you, is why he
writes his rules down so he can remember them and follow them! You break these
rules, you are gonna lose. If you want to trade, you need these near your desk.
But a lot of the others had me curious as to what they would contribute. Many of
them could have done several chapters or even books, (and most of them have!).
But to cut it down to Just One Thing? That was hard.
OK, Andy Kessler gives us two. But when you turn $100 million into a cool $1
billion, and get out at the top, two ideas are a good thing. Kessler shows how
investing in what everyone already knows is how to get average returns (or
less!). Better, he says, to invest like you are walking in a fog. This chapter
is so compelling and well written, I guarantee you cannot put it down once you
have started.
Gary Shilling shows us the value of one really good idea. It made his career.
George Gilder tells us that in fact inside information is the best information.
I leave it to you to read why. Bill Bonner tells us that we need to first start
with a principle if we want to succeed and then shows us his idea as to what
that is. Mike Masterson looks at the same thought, but comes away with an
entirely different take.
Want to average almost 3% a year better on your funds? Rob Arnott writes
compellingly that the way index (and many mutual) funds are currently
constructed is inefficient and offers a new way to invest. This powerful
analysis could be worth a lot to you. My side prediction? The revolutionary new
indexing method that Arnott lays out will be the dominant index investing style
within ten years. Arnott will go from running almost $10 billion today to
several hundred billion in a few years and within ten will eclipse the large
index funds like the Vanguard S&P 500. A bold reckless prediction? Not at all
when you understand what Rob has done. Rob has found a way to put fundamental
value into index investing. It is worth an extra 3% a year. Now THAT is a
chapter you will want to read.
James Montier gives us a very thorough overview of the latest research on the
human foibles in investing. He is an expert on the psychology of investing,
having literally written the book. In fact, his book is one of the textbooks
used to teach the subject. I got him to give us a very easy to read summary.
This is one you will want to read and re-read and come back to often.
Richard Russell, who has been writing The Dow Theory Letter since 1958 and is
the dean of economic writers, gives us his thoughts on time, hope and the power
of compounding. Anytime Richard talks, we should listen.
My good friend Ed Easterling shows us that risk is not a knob. "The first step
toward making money is not losing it," he writes, and shows us how to avoid
unnecessary risk while making it our friend when we do encounter it. Isn't that
something we all want to do? Ed shows us how.
And finally, I weigh in with a few thoughts on the power of change in our
future. The pace of change is accelerating, and we not only need to know what is
changing but how to take advantage of it. The best investments of the next 20
years will be those that are part of the process of change. I call my chapter
The Millennium Wave. I have been working and thinking on this topic more than
any other for the last ten years.
I am proud of this book and the work my friends have done to bring you their one
best idea. I believe you will find many nuggets you can use in your own life and
investing. As to the order of the chapters, it was just too much to decide who
should be first and then second and so on. Each chapter is a "lead" chapter. So
I let the way they were organized in my inbox be the prime factor. So, start at
the beginning or in the middle or the end, but read them all.
And Just One More Thing. There are a lot of great ideas in the few hundred pages
of this book. But you have to put them in practice, and to do that you have to
get the book and start reading it now. So as you read, think about how you will
put the principles, tips and ideas to use in your personal life. And that will
make this book be a very good thing.
You can get Just One Thing at your local bookstore or order it at a 34% discount
from Amazon.com as part of a special promotion to celebrate the. Don't
procrastinate. Order your copies from Amazon at just $16.47 and copies for your
friends and family at the special price. Get two and get free shipping! www.amazon.com/justonething
Can I Ask a Personal Favor?
If you are planning to buy a copy of Just One Thing, would you do me a favor and
do it this weekend on Amazon or your bookstore? Having a high rank on Amazon
actually helps bookstore sales, and bookstore sales mean they order more books
and give the book better placement. Getting off to a big start is really very
helpful. I know I and my fellow writers would appreciate it.
And I guarantee the book will make a great Christmas present. It is fun and easy
to read. Did I mention I was proud of this book and the work my friends put into
their chapters? So buy a few extra while you are online! And now back to some
thoughts on pension funds and retirement.
Corporate Pensions Down $450 Billion and Counting
This week I came across a very thoughtful article entitled "The End of Pensions"
by Roger Lowenstein in the New York Times. (Lowenstein wrote a great book on the
Long Term Capital debacle called "When Genius Failed.") He makes the case that
corporate pensions are underfunded to the tune of $450 billion. Public
(government) pensions are underfunded at LEAST another $300 billion. "According
to Barclay's Global Investors, if you use realistic assumptions, the total
underfunding in all public plans is on the order of $460 billion. If this figure
is even close to true, future taxpayers will be hopelessly in hock to the
police, firefighters and teachers of the past." (NYT) But that is not the whole
story.
I wrote two years ago in Bull's Eye Investing that the firms in the S&P 500
which had defined benefit pension plans were underfunded by $243 billion (CSFB
study). The same group suggests that these same companies will still be
underfunded by $218 billion at the end of this year. Think about that. We have
seen the market rise almost 20% since that first study, profits at corporations
have sky-rocketed, and yet liabilities only dropped 10%. Even in a rising
market, the companies did not make significant headway in solving their pension
problems.
Now, most of that liability is from companies that are solvent and at the end of
the day will be able to meet their pension obligations. But a significant
portion will not be able to. The PBGC tells us they are $23 billion in the red
at the end of 2004. This is expected to rise to $30 billion when the books for
the third quarter are closed. A Congressional Budget Office (CBO) report last
week predicted a jump in PBGC liabilities to $87 billion over the next decade
and $142 billion in 20 years. For reasons outlined below, I think it could be
worse.
But the American Benefits Council (ABC) says the PBGC is overstating the case in
order to get additional funding. In a recently issued report, the Council
concluded that the interest rate used to calculate pension obligations, now less
than 5%, is too low, and that the PBGC shortfall would be only $14.3 billion if
a 6.2% corporate bond rate were adopted. That makes a nice assumption, as AAA
corporates are paying 5.39% today. To get an average 6.2% you have to move out
toward riskier bonds, which PBGC is unlikely to do.
In the last three years, almost 600 companies have reneged on pension-fund
obligations, with 21 plans each totaling $100 million or more, topped by
United's pension fund failure at $9.8 billion, the biggest since the government
began guaranteeing pensions in 1974. In June, Delta Air Lines and Northwest
Airlines told Congress their plans would default unless legislators extended the
funding deadline. The automakers, short by $55 billion to $60 billion, may not
be far behind.
The CBO study makes assumptions about defaults that may be optimistic. Just as
the steel industry threw its pension obligations on the PBGC, we're watching the
airline industry do the same. With Delphi filing for bankruptcy, how long will
it be before the automobile industry takes advantage of government pension
insurance that you and I will ultimately have to pay for?
The ABC study does make a useful point. Your assumptions can make a large
difference in what your expected liabilities are. And I think pension funds may
be in danger of over estimating their future returns and under estimating their
future liabilities. Let's look at future returns first.
Most corporate pension funds, assume they are going to make 8% compounded
returns over the life of their fund. Let's take a typical portfolio mix of 60%
stocks and 40% bonds. Let's be generous and assume that ABC is right and that
pension plans can get 6% on their bond portfolios. That means they will have to
get slightly more than 9% on their stock portfolio in order to have a blended
return of 8%. How likely is it that the pension funds will get 9% on their stock
portfolios over the next 10 years? The answer is not very.
What Will the Stock Market Return over 10 Years?
In the chart below, Jeremy Grantham breaks down historic P/E ratios into five
levels, or quintiles, from level (or quintile) 1, which represents the 20% of
years with the cheapest values (lowest P/E ratios) in history right on through
the fifth quintile, which represents the 20% of years with the most expensive
values.
What kind of returns can you expect 10 years after these periods, on average?
Interestingly, the first two quintiles, or cheapest periods, have identical
returns: 11 percent. That means when stocks are cheap, you should get 10 percent
over the next 10 years. The last, or most expensive period, sees a return over
10 years of zero percent.
Today the price-to-earnings ratio on the S&P 500 is 18.91. That is within the
most expensive 20%, but not at the extreme. Even if you want to play games and
use very optimistic forward projections, we are still well within that fourth
quintile.
Being optimistic, you can make the case that over the next ten years you might
be able to see a 4-5% return on your stock portfolio. Being less optimistic,
with an eye to history you would project 2% or less.
But for the moment let's be optimistic. A 4% return on stocks and a 6% return on
bonds will mean an almost 5% total return for a pension portfolio. What will
that 3% difference mean? On a $1 billion portfolio, it would mean an almost $400
million shortfall over 10 years.
And what if we are pessimistic and assume a 2% stock market return and a 5% bond
market return? Then we would be looking at a shortfall of over $500 million.
On trillions of dollars in public and private pensions, we are talking massive
trillion dollar shortfalls that will have to be made up by either tax-payers or
shareholders (out of corporate profits). And every dollar that is not funded now
is a dollar that is not earning returns so the effect gets compounded.
What Happens If we Live An Extra Ten Years?
I have been writing in recent weeks about the medical advances that are coming
in the next 10-15. There are serious medical practitioners who believe that we
will be able to radically slow the aging process within 15 years. Within 10
years, a lot of the diseases that kill us today will no longer be the threat
that they are. It is very likely that Alzheimer's, if not cured, will at least
be controllable. Certain cancers and some types of heart disease may finally be
cured.
Pension plans are simply not prepared for their "younger" retirees to live an
extra 10 or 15 years. While they will be healthier, so that medical costs will
be somewhat more controlled, retirement benefit assumptions get blown to Hades
with an extra 5 or 10 years of life. My research suggests that 5 or 10 years is
not just possible, but is likely!
That means many of us will live a lot longer than we planned! While that is good
news, it also creates problems for pension funds, especially in the early 2020s
when we will see the benefits of the biotech revolution really begin to take
shape.
In the mid-80's, there were 112,000 defined benefit plans. Today there are just
over 31,000. As more and more executives realize that making commitments for 40
to 50 years into the future is fiscal insanity in a world of accelerating
change, we will see the number of defined benefit pension plans drop even more.
But it is not just the fiscal insanity that should lead executives to abandon
defined benefit plans. Let's assume you have an employee that is 50 years old
and has been working for you for 25 years. It is highly likely that he is going
to live to at least 90 if not 100 years old. He is planning on retiring in 10 to
15 years with that nice retirement you promised, indexed to inflation of course.
But the reality is that few companies will be able to fund that plan 30 years
from now, let alone 40 or 50. The world is going to be so completely different
from what it is today that no 30 year plan will survive intact. We are no longer
living in the 1950s or 60s when such long-term planning made sense. It borders
on the immoral to allow a worker to retire, thinking they are set for life, when
those promises are going to go up in smoke. Or they will be handed over to the
PBGC where taxpayers will get the privilege of making those payments.
So, am I slitting my wrist over this? No. Because these nightmare scenarios will
ultimately not play out. Corporations will either abandon their defined benefit
plans, or at the very least change the nature of the contract. Governments will
be forced to change their plans. Things are going to change, because they will
have to.
The social contract between generations is going to change throughout the
developed world as the needs of an older generation clash with the means of a
younger one. Over the next year, I am going to think and write more about this,
as I think it will be the defining event of the first part of the century, more
so than any other.
And for those of you who do not have to worry about whether your pension will be
around in 25 years? You had better plan on saving more than you thought. The
good news is that you will probably live longer. You want to make sure you do
not live past your savings.
Europe, Canada, New York, London and Amazon
I am in the process of re-writing and re-doing all my websites. We now have new
sign-up forms for my accredited investor website for Europe and Canada. If you
live in those parts of the world, you can go to www.accreditedinvestor.ws and
sign up and get information on various hedge funds and alternative investments.
I work with my partners Absolute Return Partners in Europe (they are based in
London), and with Pro-Hedge in Toronto, Canada. They will call you and show you
the funds we like. If you live in those areas and have already signed up, I
would suggest you sign up again, as we have new items and privacy rules which we
have enabled, which allows us to be in contact with you.
If you are in the US, and are an accredited investor (basically $1,000,000 or
more net worth), you can go to the website and sign up as well. I work with my
friends at Altegris Investments to help you find information about hedge funds
and other alternative investments. The website explains exactly how we work (it
is basically the same for Canada and Europe). (In this regard, I am president of
and a registered representative of Millennium Wave Securities, member NASD.)
I am going to be with Jon Sundt and Matt Osborne of Altegris in New York week
after next for a conference and then they have talked me into jumping over the
pond to London to look at a few funds. But then I am back home and have nothing
scheduled for two months, but you know that will change.
I just got back from Detroit this afternoon where I spoke to a very nice group
at the local chapter of the World Presidents Organization, and good friend Jerry
Wagner of Flexible Plans took me to the home opener of the Detroit Pistons. He
has seats on the floor under the basket. Tomorrow, I will go to my second home
opener this season where I will see my Dallas Mavericks. My seats aren't quite
as good, but almost. Then Sunday, Beau Johnson found some NASCAR tickets for me
and my son. The good news is that they are in a suite, so there will be some
comfort. I have never been to a NASCAR race, but my son is nuts about cars, so
we will have fun watching rednecks chase each other around an oval track (just
kidding, guys!). Add some work, a few workouts and the usual chores and it is
going to be a busy weekend!
Small confession. I have "only" checked Amazon.com about 10 times today to see
what the ranking is. I will probably do so for a few weeks. Just the competitive
nature and curiosity. It would be fun to be #1 for a few hours, but knocking off
an Oprah book club recommendation from #1 is pretty hard. But I can dream over
the weekend. And the weather here (and in Detroit) is/was perfect. Going to be
some fun.
And yes, click here and buy Just One Thing now while you are thinking about it. www.amazon.com/justonething.
Note: PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL
AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS OR ANY ALTERNATIVE
INVESTMENT PRODUCT.
WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD
CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN
LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK
OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC
PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX
STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT
TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND
IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY
TO THE INVESTMENT MANAGER.
The Accredited Investor E-letter is not an offering for any investment. It
represents only the opinions of John Mauldin and Millennium Wave Investments. It
is intended solely for accredited investors who have registered with Millennium
Wave Investments and Altegris Investments at www.accreditedinvestor.ws or
directly related websites and have been so registered for no less than 30 days.
The Accredited Investor E-Letter is provided on a confidential basis, and
subscribers to the Accredited Investor E-Letter are not to send this letter to
anyone other than their professional investment counselors. Investors should
discuss any investment with their personal investment counsel. John Mauldin is
the President of Millennium Wave Advisors, LLC (MWA), which is an investment
advisory firm registered with multiple states. MWA is also a Commodity Pool
Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC,
as well as an Introducing Broker (IB). John Mauldin is a registered
representative of Millennium Wave Securities, LLC, (MWS), an NASD registered
broker-dealer. Millennium Wave Investments is a dba of MWA LLC and MWS LLC.
Millennium Wave Investments and Altegris Investments are independent firms that
cooperate in the consulting on and marketing of private investment offerings.
Funds recommended by Mauldin may pay a portion of their fees to Altegris
Investments, who will share 1/3 of those fees with MWS and thus with Mauldin.
Any views expressed herein are provided for information purposes only and should
not be construed in any way as an offer, an endorsement, or inducement to invest
with any CTA, fund, or program mentioned here or elsewhere. Before seeking any
advisor's services or making an investment in a fund, investors must read and
examine thoroughly the respective disclosure document or offering memorandum.
Since Altegris and Mauldin receive fees from the funds they recommend/market,
they only recommend/market products with which they have been able to negotiate
fee arrangements.
Your hoping to make it to #1 analyst,
John Mauldin
JohnMauldin@InvestorsInsight.com
www.2000wave.com
November 5, 2005
Copyright 2005 John Mauldin. All Rights Reserved.
If you would like to reproduce any of John Mauldin's E-Letters you must include the source of your quote and an email address (John@frontlinethoughts.com) Please write to Wave@frontlinethoughts.com and inform us of any reproductions. Please include where and when the copy will be reproduced.
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staff at Thoughts from the Frontline may or may not have investments in any funds cited above. Mauldin can be reached at 800-829-7273.
Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs at Millennium Wave Advisors, LLC may or may not have investments in any funds cited above.
PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.
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