The inspiration for this week's commentary comes from a book about the dismal science: “Economics of the Undead” (Rowman & Littlefield Publishers, 2014). In it, authors Glen Whitman and James Dow combine essays from various contributors on the economic implications of vampires and zombies. With Saturday being Halloween, I’d thought I’d extend their theme to investing.
Like Whitman and Dow, I’m going to focus primarily on vampires and zombies. These creatures are particularly useful for discussing investing because of their contrasting cognitive abilities and needs.
Treat Longevity as a Big Risk: Longevity is the uncertainty of how long you will live. Though our natural lives are finite, we cannot quantify how finitely with accuracy. As such, we have to guard against the threat of living longer than expected. When a person is turned into a vampire, longevity risk increases considerably. As long as a vampire avoids sunlight, wooden stakes and—in some books and movies—silver, the undead creature could last centuries and will thus need his or her money to last centuries as well. Zombies, conversely, shorten longevity risk. Since zombies [using George Romero’s “Night of the Living Dead” (1968) as the authority on the subject] are only interested in flesh, they have no need for any assets besides living humans. You and I are in between: We need our money to last an unknown, but finite period of time. The penalty for underestimating how long we will need our money to last can be greater than the penalty for overestimating. In fact, we may desire an excess so we can pass it along to family members or charities and religious institutions.
Realize That Costs Matter: Costs have an indefinite life span, as long as assets exist. For example, a vampire needs a place to hide from the sunlight. Whether it be a castle, a mansion or some other dwelling, upkeep does not come free. These expenses increase on an absolute basis over time. They also suck money out of the portfolio. Thus, the prudent vampire will seek to keep costs as low as is reasonable since every dollar spent on expenses is a dollar never to be seen again. Prudent living investors should do the same.
Make Time Your Friend: Part of the reason costs matter is that they reduce the amount of wealth available to take advantage of compounding. In “Economics of the Undead,” Dow notes that vampires have the ability to put some money aside in various investments and then go to sleep for 100 years. One of the best thing an investor can do, living or undead, is put money into a low-cost, well-thought-out portfolio and do nothing for years other than periodically make adjustments for when things go off track (e.g., your equity allocation is 10 percentage points higher than your targeted allocation). The longer a person can stay exposed to stocks, the higher the odds of wealth creation are.
Understand the Danger of Poor Estate Planning: If a vampire intends to sleep for an extended period of time, the nighttime creature must ensure his or her property is cared for. This requires foresight with instructions for what should be done (e.g., the master vampire in “The Strain” arranged to have his coffin transported to New York City). Living humans have the same requirements when it comes to their estates. Wills are required to ensure the estate is properly settled. Powers of attorney, trusts and even simple emergency instructions are needed to allow a trusted person to step in and make decisions when one’s cognitive abilities are compromised by dementia, injury, stroke, illness or a zombie bite. Failure to plan can lead to unwanted outcomes, including probate and loss assets. (Perhaps, the reason so many haunted houses are inhabited by angry spirits is a lack of proper estate planning…)
Consider Scarcity When Making Financial Decisions: We all have limited resources. As such, we need to try to be rational about how we allocate them. For example, say you are trying to escape the zombie apocalypse. What should you bring? Though you might have your choice of what to gather if you react early enough, the penalty for bringing the wrong item with you can be high. Weight and portability are considerations since you may have to travel by foot (which is why duct tape, a knife and a good pair of boots would be high on my list.) When it comes to investing, you have only X amount of dollars to allocate, Y dollars you can add to your savings and Z amount of time. If you are retired, you will also have to consider how much in W dollars you may need to withdraw. Coping with this reality requires being very clear about how you are allocating your money and being able to resist the temptation to add new investments or change your strategy just because you come across something with short-term appeal. Yes, it would be nice to carry along some reading material—or Twinkies, if you are Tallahassee from Zombieland (2009)—while on the run from zombies, but wouldn’t you prefer a water purification system instead?
Be Fearless About Cutting Losses: One common behavioral mistake investors often repeat is to hold onto losing investments too long. If zombies start appearing anywhere near your neighborhood, get out of town ASAP! The same goes for poltergeists in your house. (Even Rick Grimes, the main character of The Walking Dead graphic novels and accompanying TV show, has been forced to abandon many residences in order to stay alive despite his well-established survival skills.) The same logic applies to a stock, bond or fund that turns out to be bad a decision [e.g., earnings keep falling, the bond’s credit rating is cut, the fund’s expense fees keep eating up any excess returns, the company’s genetic lab unleashes a virus that turns its staffers into the undead as occurred in Resident Evil (2002), etc.] Be ruthless about abandoning a haunted house and an investment that clearly violates your sell rules, regardless of how big a loss you may incur at that moment. [As far as vampires are concerned, it may depend on if we’re talking about Edward Cullen from the Twilight series, who abstains from drinking human blood, or Bela Lugosi in “Dracula” (1931).]
Know What the Real Threats Are: The risks of a vampire or a zombie apocalypse are nil. Though making for entertaining books, movies and TV shows, they are just fiction. However, the big long-term risks you face—longevity and preserving your ability to buy goods and services with the money you have (“purchasing power”)—can be overshadowed by short-term risks that are far easier to identify, such as monetary policy, prevailing market trends or politics. Even if you are aware of the risks you should focus on, it can be easier than you realize to be swayed into changing your viewpoint of risk. A case in point is Canadian solider Stanley MacDonald, who was convinced not to worry about the zombie threat in “World War Z: An Oral History of the Zombie War” (Three Rivers Press, 2007), despite his own personal encounter with a zombie.
Stay Disciplined: Above all else, take the advice of Carl Richards: behave well for a very long time; because as Michael Jackson—who made millions off of hits such as "Thriller" (you really didn’t think I’d go without making at least one reference to dancing zombies, did you?)—showed, no amount of money is too large for a mortal to spend.
Budget Legislation Has Tricks and Treats for Near-Retirees and Retirees
The budget legislation passed by the U.S. House of Representatives yesterday contained two provisions of particular interest to those who are either near or in retirement.
The first provision of note ends the ability to file for and suspend Social Security benefits. Under this strategy, one spouse (I’ll use the husband in this example), files for benefits at his full retirement age and then immediately suspends his benefits. The second spouse (the wife in this example) then files for spousal benefits based on the husband’s income record. The husband waits until age 70 to take his full benefit, which has increased because he had suspended taking his benefit.
A second provision halts the potentially large increases in Medicare premiums and deductibles some may have seen next year, despite no inflation adjustment in Social Security benefits. The New York Times says the basic Medicare premium will rise to about $120 per month for 30% of beneficiaries, instead of $159. The increase in the annual deductible will also be lower: about $167 instead of $223.
As of this afternoon, the bill had yet to be voted on by the U.S. Senate, so there is the possibility of revisions to or the outright elimination of these provisions. If the final bill signed into law by President Obama contains these provisions, the elimination of file and suspend would not take effect for an additional 180 days. The Medicare premium and deductible changes would be effective in 2016.
- How Big Is Longevity Risk? – Bob Collie of Russell Investments explains how longevity risk changes relative to investment risk as a person ages (assuming, of course, they aren’t turned into a vampire).
- Social Security Strategies for Couples – File and suspend is just one of the strategies couples can use to maximize their Social Security benefits.
- What Was the Scariest Investment You Ever Made? – Tell us on the AAII.com Discussion Boards.
Our Investor Conference will start next Saturday, in Las Vegas. Those of you not attending can purchase audio recordings of the presentations.
It will be another very busy week for earnings, though we will see more mid-cap and small-cap companies report. Large-cap companies will still be active, however, with nearly 100 S&P 500 members on the calendar. Included in this group are Dow Jones industrial average components Visa (V) on Monday and Walt Disney Company (DIS) on Thursday.
The first economic reports of note will be the October ISM manufacturing index, September construction spending and the October PMI manufacturing index, all of which will be released on Monday. Tuesday will feature September factory orders. The ADP’s October employment report and September import and export prices will be announced on Wednesday. Thursday will feature the first estimate of third-quarter productivity as well as the weekly initial jobless claims data. October jobs data—including the unemployment rate and the change in nonfarm payrolls—will be released on Friday.
Several Federal Reserve officials will make public appearances, as is typical following a Federal Open Market Committee meeting. Philadelphia president Patrick Harker and Vice Chair Stanley Fischer will both speak on Wednesday and Thursday. New York president William Dudley, Chicago president Charles Evans, Governor Daniel Tarullo and Atlanta president Dennis Lockhart will speak on Thursday. On Friday, St Louis president James Bullard and Governor Lael Brainard will speak.
- 16 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses
- Avoid the Top 10 Mistakes Made With Beneficiary Designations
- Calculating Intrinsic Value With the Dividend Growth Model
Optimism among individual investors rose to its highest level and pessimism fell to its lowest level since February, according to the latest AAII Sentiment Survey. Neutral sentiment, meanwhile, continued to stay above its historical average.
Bullish sentiment, expectations that stock prices will rise over the next six months, surged 5.6 percentage points to 40.4%. This is the first time optimism has been above 40% since February 26, 2015 (45.4%). This week’s jump also ends a record 33-week stretch of bullish sentiment readings that were below the historical average of 39.0%. (Optimism was at 39.8% on March 5, 2015.)
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, pulled back by 2.2 percentage points to 39.0%. Even with the decline, neutral sentiment remains above its historical average of 31.0% for the seventh consecutive week and the 41st week this year.
Bearish sentiment, expectations that stock prices will fall over the next six months, fell 3.4 percentage points to 20.6%. Pessimism was last lower on February 26, 2015 (20.3%). The historical average is 30.0%. This week’s drop puts bearish sentiment at the bottom of its typical range.
Since jumping to 39.9% on September 30, 2015, as the S&P 500 retested its August lows, pessimism has fallen by a cumulative 19.3 percentage points. Optimism, conversely, has only risen by 12.3 percentage points over the same period and has shown greater week-to-week variance. (Pessimism has declined for four consecutive weeks.) The shift has occurred as the S&P 500 has rebounded and is now nearing its pre-correction levels.
In addition to market trends, short-term sentiment among AAII members is being impacted by global and international events (particularly China and global economic weakness), U.S. monetary policy, U.S. politics and the pace of U.S. economic growth. Third-quarter earnings surprises may also be having an impact.
This week’s special question asked AAII members what type of candy they will be giving out to trick-or-treaters on Halloween. More than half of all respondents (52%) said either chocolate or candy bars. Snickers bars and Hershey’s products were named the most, each by about 8% of all respondents. Also popular were Reese’s peanut butter cups, Butterfinger bars and Milky Way bars. About 24% of respondents said they will not give out candy, primarily because of an expected lack of trick-or-treaters or plans to be out on Saturday evening.
Bullish: 40.4%, up 5.6 points
Neutral: 39%, down 2.2 points
Bearish: 20.6%, down 3.4 points
Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Local Chapter Meetings
October 22, 2015 FINRA’s Proposal to Halt Elder Fraud: Stop Withdrawals
October 15, 2015 Criticism of Target Date Funds Is Misplaced
October 8, 2015 A Major Rule Change for Mutual Funds and ETFs
October 1, 2015 Notes From the Morningstar ETF Conference
