Cost of Retirement

Most of us assume that the cost of living for a retiree is less than that of the average working adult. MarketWatch has an article by Robert Powell, which discusses how much retirment expenses actually are.

Retirees spend more on healthcare and insurance than a working adults, but what about their other expenses? Hopefully by retirment you will have your house paid off. You will not have work-related costs, such as clothing or transportation costs.

MarketWatch quotes a study, "Understanding Expenditure Patterns in Retirement," published by the Boston College Center for Retirement Research. The study shows that the typical married couple, ages 65 and older, spend about $15,000 annually. The top 20% of retirees spend around $25,500, and the bottom 20% have expenses just over $10,000.

Richard Johnson, an author of the study, broke down the average retirees expenses.

• 29% - housing
• 20% - health care
• 8% - health insurance
• 6% - prescription drugs
• 4% - health services
• 1% - medical supplies
• 13% - food
• 12% - transportation
• 10% - entertainment
• 10% - gifts

There are a few reason for the great expense on housing. One reason is that one quarter of retirees still carry a mortgage. The rising cost of property taxes, utilities, and maintenance also increase the cost of housing. He also points out that the married couple spends 84% of their aftertax income.

Mergers

There have been a lot of mergers recently, and don't expect the pace to slow down.

• 1/28/05: Proctor & Gamble announces intent to buy Gillette for $57 billion
• 1/10/05: News Corp. announces intent to buy Fox Entertainment Group for $6.8 billion
• 12/16/04: Johnson & Johnson announces intent to buy Guidant Corp. for $25 billion
• 12/15/04: Sprint Corp. announces intent to buy Nextel Communications for $35 billion
• 12/13/04: Oracle Corp. announces intent to buy Peoplesoft Inc. for $10.3 billion
• 11/17/04: Kmart announces intent to buy Sears, Roebuck & Co. for $11 billion

The economy is in a great position to encourage mergers currently. We have low interest rates. Companies have more cash on hand than they have had in years. The dollar has a low valuation, which gives foreign companies incentive to buy American companies.

There were $544 billion of mergers in 2003, and $767 billion of mergers in 2004. I predict that we will exceed all these previous levels and set a new record that will surpass 1987 when there were $887 billion in mergers.

Russell 2000 Calls

Well my Russell 2000 January Calls expired. If I had followed the advice in the article I would have lost about half as much as I did. I expected the index to go up, thus by buying earlier, I had the potential for more profits. Also I should have bought a call which was out of the money, which would have cost less. Thus I made two poor decisions and lost $4 on each option.

I think the main reason the index went down during the period of the option was the worries about Iraq. I think once the election is done, that the market will start to make the gains that I was expecting in December and January.

At the end of this year, if I think the market is in good condition, I will probably buy more Russell 2000 options. But I will make better decisions, unlike what I did last year.

Notes from July 2004 Money

I didn't find a lot of useful information in the July 2004 Money magazine. But here are a few of the interesting points...

• Stocks historically do well after an initial rate hike, at least in the short term. Since 1928 the S&P 500 index rose 9% in the year following the Fed's first rate hike.
• Growth stocks do well in the early stages of a period of rising rates. When the 30-year bond yield rises 10%, the best perfoming stocks are from growth industries.
• In the last four rising-rate periods, short term bonds gained ground, while long-term bonds tanked. A difference of at least 9% in each case was observed.
• Many investment pros recommend investing some of your money in REITs because they don't move in sync with stocks and bonds. This allocation can reduce the volatility of your portfolio.

Long-Term Care Insurance

Money magazine (Sept. 2004; pgs. 112-120) has an article discussing long-term care insurance and who should get it. This article points out the costs of the insurance, and when it should be bought.

Annual long-term care premiums start at $500 for 40 year-olds, and $1,300 for 65 year-olds. These policies are generally not used until age 82. These policies are so expensive, and the premiums rise so quickly, that one third of policy holders let the insurance lapse. A Kaiser Family Foundation study found that only 20% of couples between ages 35 and 59 can afford long-term care insurance without risking retirement funding, and more urgent insurances such as life and disability insurance.

According to AARP research, people over the age of 65 have a near 70% chance of needing assistance due to a disability. This statistic includes minor and short-term care the the policies won't cover. A New England Journal of Medicine article concluded that 23% of those who were then 65 would spend a year or more in a nursing home, and 9% would spend five or more years.

Before you buy a long-term care insurance you should examine your finances. Planners say that if your assets at retirement are between $200,000 and $1.5 million you are a candidate for long-term care insurance. If you have less, you can't afford the coverage. If you have more than $1.5 million you may not need it. You could probably afford the care yourself, if it is ever necessary. You are also a candidate if you want to protect your estate, or have a medical history that puts you at higher risk for nursing home care.

Another important decision to take into consideration is when to get coverage. Many planners argue that around 60 years old is a good time to purchase coverage. Premiums rise with age, but don't spike until age 65. The fear of uninsurability isn't necessarily a reason to buy young. According to Kaiser, nearly 80% of people from ages 60-65 pass underwriting screens.

There are other reasons to wait until you are nearing retirement. When you are 40 years old, it is difficult to figure out what your retirement income will be, what care options will exist, and what policies will be available.

Several things to keep in mind when buying long-term care insurance are:

• Insurer: Will the insurer be around when you need the coverage?
• Benefit Period: Only 9% of people need care for more than 2.5 years.
• Elimination Period: How long until you qualify for coverage?
• Daily Benefits: Find out how much care is in your area, then add 5% annual price increases.
• Inflation Protection: This is a very important feature to have.

Dividends Rule

Money (Sept. 2004; pgs. 88-92) has an article discussing the benefits of dividend bearing stocks and how to pick the right ones for maximum investment returns.

During 2004, up to the publication of the article, dividend bearing stocks had outperformed non-dividend bearding stocks by 11.4%. The PE ratios between growth stocks and blue chip stocks is about half of what it was in 2000, though this is due to the drop in the prices of growth stocks during the bear market.

Research has found that it is best to invest in stocks that have high dividend growth, rather than having the highest dividends. The article recommends looking for what they call growth and income investments. It recommends looking for a yield between 2% and 4% with annual earnings growth of at least 9%. The best values will trade at a PE ratio of less than 20 times the following years earnings.

Average Investor Returns

Money (Sept. 2004; pgs. 83-87) has an article that discusses the market returns that the average investor has gotten. Ilia Dichev of the University of Michigan found that the New York stock exchange and the American stock exchange investors returns lagged market returns by 1.3% between the years of 1926-2002. Nasdaq investors lagged the market return by 5.3% from 1973-2002.

Jason Zweig of Money magazine and three other finance experts performed study in 2002. They watched the money moving in and out of 6,900 U.S. stock funds between 1998-2001. They found that the average fund returned 5.7%, while the average investor only earned 1% due to poor timing.

Historically stocks have outperformed inflation over all holding periods of at least 20 years. Bonds have underperformed inflation over long stretches, but can outperform inflation over shorter terms. Unfortunately only three other stock markets have outperformed inflation over similar terms.

John Bogle, founder of Vanguard funds, says that stock gains come from two sources: the "investment return" (dividends plus earnings growth) and "speculative return" (how eagerly investors bid stocks up, or down, over time).

Dividends have plummeted from a 4.3% average to 1.7%. This wouldn't be bad if the money was invested in growing the business. Unfortunately this money in invested in buying other companies, or to cover stock options granted. This doesn't help the companies. Earnings growth has averaged 2% annually, over inflation. If you add in the current average dividend yield, returns are only around 3.5%-4%.

The price to earnings (PE) ratio of stocks started the 20th century around 13.5. They rose from a low of 8 in 1982 to 33 in 2000. Stocks now trade around a PE ratio of 20.

Only three markets in three countries have posted better inflation adjusted returns than the U.S. in the past century. More than half the world's stocks are traded outside the U.S. Money feels that at least 25% of your portfolio should be in foreign stocks as a hedge against local market calamities.

Finally they recommend making sure you have human capital (good career and education), physical capital (your house and other possessions), and financial capital (stocks, bonds, and cash). You can hedge your resks by picking up new job skills, buying a second home elsewhere, and diversify your investments.

The "Dollar-Cost Averaging" Myth

This article points out that Dollar-cost averaging is not a guaranteed way to make money. We all should have know this, but the way it is marketed, it looks like it is an excellent way to make good returns off your investments.

I think that putting yourself on a schedule to invest is a good way to invest though. That doesn't necessarily mean that you have to invest the same amount every month. I think that if you have an investment schedule, than you are more likely to maintain it, then if you just invest when you think about it.

I have several DRiP accounts, one of which is in Pfizer (PFE). Currently I am down on my Pfizer investment, but I feel that this is a good company to invest in. So when it dropped earlier this year, I increased my monthly contribution to that account.

I also have a DRiP account in a regional bank that charges for automatic investments, but does not charge for optional cash purchases. So I invest when I have spare money, or I feel the stock is at a good point for investment.

I will have an article on DRiP accounts in the near future, so you will have a better idea of what they are and how they work.

Check Your Credit Report

A U.S. Public Interest Research Group study found that 25% of consumer credit reports contained errors serious enough to lead to a denial of credit.

If you are on the western third of the United States, you can request your annual credit report right now. The western third was able to start requesting on December 1, 2004. The midwest can start requesting credit reports on March 1. The southern states can request credit reports on June 1. Finally the eastern states and all U.S. territories can request credit reports on September 1.

The FACT Act amendment to the Fair Credit Reporting Act allows you to request one free credit file disclosure in a 12-month period. You can request a free report at AnnualCreditReport.com or call toll free (877) FACT-ACT. The site also has a map so you can look to see where your state is, and when you can request your free report.

If you want to check your credit report and your state doesn't have free credit reports yet, you can check them at the three consumer credit agencies: Experian, Equifax, and TransUnion for a fee of around $10.

Decade Analysis

The Dow has performed extremely well the last hundred-plus years when the years ended in a "5".

Year Ending in...	gain/loss
0	-6.9%
1	-0.8%
2	2.4%
3	6.8%
4	9.8%
5	31.6%
6	5.8%
7	-3.1%
8	18.5%
9	9.2%

Also the major U.S. markets have performed very well the last 30 years when the year ended in a "5".

	1975	1985	1995
Dow	38.3%	27.7%	33.5%
S&P 500	31.5%	26.3%	34.1%
Nasdaq	29.8%	31.4%	39.9%

data taken from this article.