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May 1, 2019: Social Insecurity?

“Sometimes I wonder whether the world is being run by smart people who
are putting us on, or by imbeciles who really mean it.”

                                                                                                Mark Twain

 

You may have seen headlines referencing Social Security’s financial challenges following the recently-issued annual report from the trustees of the Social Security program.  Social Security is often referred to as the “third rail” of politics given the high risk politicians feel they will take on if they propose ways to shore up its finances.  The solution lies in raising taxes, cutting benefits, or a combination of the two.  For those who love to be loved, these are not very palatable choices!

Brief History of Social Security:

The Social Security program started in 1935 as a response to the widespread poverty and unemployment caused by the Great Depression, as well as a means to address the increasing economic insecurity of older Americans following the Depression-induced depletion of private pension plans.

The initial version of Social Security was more of a funded insurance program than what we have today.  The program initially covered workers only, and stressed the importance of being fully-funded to provide for projected benefits.  Most workers retired at 65, and life expectancy was significantly shorter than it is today.

Various amendments in 1939 added dependent and survivor benefits, and also accelerated benefits so that workers who had contributed to the system for only a few years received full retirement benefits.  This changed the system from a funded insurance program to a pay-as-you-go program whereby current workers finance the benefits of current retirees.

After years of deteriorating Social Security finances during the 1970s, the National Commission on Social Security Reform (also known as the Greenspan Commission) was formed.  The Commission’s recommendations that were adopted by Congress in 1983 included raising the age at which a retiree could receive full benefits, increasing payroll taxes, and subjecting a portion of Social Security benefits to income taxes for certain recipients (based on their level of income).

The changes enacted in 1983 translated to a nearly 30-year period during which inflows from payroll and income tax exceeded benefits paid.  These excess inflows were accumulated in the Social Security trust fund that grew to $2.6 trillion by 2010.

Social Security Today

Since 2010, Social Security benefits paid have exceeded income from payroll and income taxes, meaning that the remainder of benefits had to be paid via the interest income on the trust fund’s assets.  The trustees of Social Security currently expect that, starting next year, interest income on trust fund assets will not be sufficient to cover the gap between benefits paid and the combination of payroll and income taxes.  Consequently, trust fund principal will be tapped in 2020 and beyond in order to cover a portion of Social Security benefits.  Using current assumptions, the trust fund principal will be fully depleted by 2035.

What Happens Next?

Once the Social Security trust fund is depleted in 2035, it is expected that payroll and income taxes will be sufficient to cover only 75% of Social Security benefits.  In other words, if legislators wait until 2035 to address this issue, it will require an immediate 25% across-the-board cut in benefits, a significant tax increase, or a combination of the two.

If legislators were to act now, on the other hand, it is estimated that a 2.7 percentage point increase in payroll taxes (i.e., from the current 12.4% to 15.1%) would be sufficient to make Social Security solvent for the foreseeable future.  Alternatively, an immediate 17% cut in Social Security benefits for all current and future beneficiaries would do the trick.  (Or, a combination of tax increases and benefit cuts would address the issue.)

Our best guess is that we will eventually see a political compromise that calls for higher payroll taxes on workers, increased income taxes on Social Security benefits, and benefit cuts in the form of reduced inflation adjustments and/or means-testing for higher-income recipients.  This would be similar to the 1983 adoption of the Greenspan Commission’s recommendations.  We are not holding our collective breath for a near-term solution, but we will keep you apprised of any significant developments.

 

Sources:

Ellis, Charles, Alicia Munnell and Andrew Eschtruth. "Falling Short: The Coming Retirement Crisis and What to do About It."

"The 2019 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Trust funds."

Munnell, Alicia. "Social Security's Financial Outlook: The  2018 Update in Perspective."Center for Retirement Research at Boston College.

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January 21, 2019: Remembering Jack Bogle

“If a statue is ever erected to honor the person who has done the most for American investors,
the hands-down choice should be Jack Bogle."

-  Warren Buffett, February 25, 2017 letter to Berkshire Hathaway shareholders

Vanguard founder Jack Bogle passed away last week at the age of 89.  After graduating from Princeton University in 1951, Bogle started his investment career with Wellington Management Company.  In 1974 he left Wellington to form Vanguard, now one of the largest investment managers in the world.

Bogle referred to his new venture as “The Vanguard Experiment,” whereby Vanguard mutual funds would be operated at-cost, similar to a mutual insurance company or other non-profit organization.  This was and continues to be a radical departure from the traditional mutual fund structure in which an external management company manages a fund or funds for profit.

Although he was not the inventor of the indexing concept, Bogle forever changed the investment management industry in 1976 when Vanguard introduced the first index mutual fund.  The goal of the First Index Investment Trust (later renamed Vanguard 500 Index) was to simply match the return of the Standard & Poor’s 500 Index, a measure of the U.S. stock market.  Again, this was a radical departure from traditional investment management strategies that sought to beat the returns of the stock market.

First Index Investment Trust was initially poorly-received, gathering only $11 million in assets via its initial offering in 1976 versus a goal of $150 million.  It was often referred to as “Bogle’s folly,” and some said it was downright un-American and represented an acceptance of mediocrity.  Edward Johnson, Chairman of Fidelity Investments at the time, doubted that Fidelity would embrace the index-investing concept and told the press, “I can’t believe that the great mass of investors are [sic] going to be satisfied with just receiving average returns.  The name of the game is to be the best.”

More than forty years later, index-investing is now widely-embraced by investors.  Low-cost mutual and exchange-traded funds tracking tax-efficient, well-constructed indexes have proven to be very difficult to beat over the long-term.  Fidelity Investments has not only joined Vanguard in offering index funds, but they recently became the first company to offer zero-cost index funds, regularly touting this fact via full-page newspaper ads and comparing their index funds to Vanguard’s index funds.  Imitation is indeed the sincerest form of flattery!

We’ll leave the last word on Jack Bogle to Warren Buffett via another excerpt from his February 25, 2017 letter to Berkshire Hathaway shareholders:

“For decades, Jack has urged investors to invest in ultra-low-cost index funds.  In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers…In his early years, Jack was frequently mocked by the investment management industry.  Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned.  He is a hero to them and to me.”

 

Past performance does not guarantee future results.  Investment strategies discussed may not be suitable for all investors.  Diversification does not guarantee against investment loss.  The information provided here is for general informational purposes only.  The inclusion of specific securities within the context of broad economic commentary is not intended to be a recommendation.  Investors should thoroughly evaluate any security before taking action.  International investments involve special risks, including currency fluctuations and political and economic instability.  Opinions expressed are subject to change without notice in reaction to shifting market conditions.  Data contained herein is obtained from what are considered reliable sources.  However, its accuracy, completeness or reliability cannot be guaranteed.

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December 6, 2018: The Return of Risk

A year ago, one of us had a discussion with the owner of his local auto repair shop about bitcoin.  At the time, the price of bitcoin had skyrocketed and appeared to be a one-way ticket to wealth.  The auto shop owner was extolling the virtues of bitcoin, not only as an investment, but as a medium of exchange.  When asked, “Would you accept bitcoin as payment for your auto repair services?” the auto shop owner unhesitatingly replied, “absolutely.”  Our observer bit his tongue and went on his way, hoping the auto shop owner had not exposed too much of his financial security to bitcoin.  Since that conversation, the price of bitcoin is down 75%.

Return of Risk:

We have expressed concerns in prior letters that the Federal Reserve’s extraordinary efforts since the Global Financial Crisis to suppress interest rates and whet investors’ risk appetites have suppressed risk premiums (i.e., reduced the potential reward for taking risk) and likely artificially reduced the fluctuations of investment markets.  As the Fed now attempts to gradually reverse its generous crisis-driven monetary policies and the investment markets grapple with other issues, risk has returned.  In fact, this may be the first year since 1972 in which none of the major investment classes returns at least 5%!  (source: Ned Davis Research)

We do not wish to sound glib or resort to a cliché, but corrections in the prices of riskier assets can be healthy in a variety of ways.  Prior to this correction, we had been concerned that the strong performance of momentum-driven and other risky investment strategies encouraged aggressive behavior on the part of investors and made investing appear to be less risky than it is.  Prolonged periods of complacency tend to end badly, so perhaps the current correction will, ironically, extend the life of the bull market that began in 2009.

Although it is impossible to know the short-term direction of markets, we think it is prudent to mentally prepare yourself for further fluctuations in the investment markets in the coming months as they adjust to higher interest rates and slowing economic and corporate earnings growth.  As we have described on numerous occasions in the past, we worked extensively earlier this year to upgrade the quality of our bond holdings given the rise in Treasury and money market yields.  These investments have recently provided solid ballast in the midst of a significant correction in global stocks, and will provide the necessary dry powder for future rebalancing opportunities.

 

 

Past performance does not guarantee future results.  Investment strategies discussed may not be suitable for all investors.  Diversification does not guarantee against investment loss.  The information provided here is for general informational purposes only.  The inclusion of specific securities within the context of broad economic commentary is not intended to be a recommendation.  Investors should thoroughly evaluate any security before taking action.  International investments involve special risks, including currency fluctuations and political and economic instability.  Opinions expressed are subject to change without notice in reaction to shifting market conditions.  Data contained herein is obtained from what are considered reliable sources.  However, its accuracy, completeness or reliability cannot be guaranteed.

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November 20, 2018: Sharp Ups and Downs

You have probably noticed the recent sharp ups and downs in the stock market. Prior to October, the well-known U.S. stock market benchmarks (e.g., Dow, S&P 500) had bucked the trend of declining stock markets outside of the U.S. that began earlier this year. Starting in October, however, U.S. stocks have joined in the downtrend.

As one of many leading indicators, the stock market downturn may be foretelling an eventual economic recession in the U.S. Although the U.S. economy has been strong and may continue to grow, albeit at a slower pace, it is quite possible that certain economies outside of the U.S. are already experiencing recessions.

In the past, global economic recessions in which the U.S. economy continued to grow resulted in less severe stock market corrections than global recessions that included the U.S. economy. According to Ned Davis Research, the average stock market correction has been around 20% during a global recession in which the U.S. continued to grow. Although the current correction may turn out to be more or less severe than the average, currently we are about halfway to the average correction. Regardless of the ultimate severity of this correction, we believe it is reasonable to assume that the bumpy ride for stocks will continue in the coming months.

As a reminder, we keep many years’ worth of cash flow needs in more stable bonds and money market for our retired clients, which means we do not expect to be forced sellers of stocks at unattractive prices. For our younger clients adding money to their portfolios, a declining stock market provides lower prices on long-term investments, which translates into higher expected returns in the future.

Past performance does not guarantee future results. Investment strategies discussed may not be suitable for all investors. Diversification does not guarantee against investment loss. The information provided here is for general informational purposes only. The inclusion of specific securities within the context of broad economic commentary is not intended to be a recommendation. Investors should thoroughly evaluate any security before taking action. International investments involve special risks, including currency fluctuations and political and economic instability. Opinions expressed are subject to change without notice in reaction to shifting market conditions. Data contained herein is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

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October 19, 2018: Feeling Old

We felt really old reading a newspaper article the other day. The title of the article was, “Professional Videogamers Hit the Gym,” and it described how those who play video games for a living are lifting weights, doing yoga, and eating healthy foods in an effort to prolong their careers.

Our reaction to this was: When the heck did playing video games become a profession?

Update on the Economy and Investment Markets:

In nine months or so the U.S. economic expansion will become the longest on record. Although we are concerned with the levels of corporate and government debt, we think the U.S. consumer is in decent shape, not to mention highly-confident. This bodes well for consumer spending in the coming months, which is a significant contributor to our economy.

As to the investment markets, another thing that makes us feel old is the fact that no one who has invested in the U.S. stock market since the global financial crisis ten years ago has experienced a bear market or a really bad year. It has been a long time since investors have been tested by a severe or prolonged economic or stock market downturn. As “old fogeys” who experienced the severe downturns from 2000-2002 and 2007-2009, we are always mindful of managing your portfolio’s risk.

You have probably noticed the increased volatility in the stock market recently. Although we cannot know the reasons for certain, presumably this has been primarily caused by a sharp rise in longer-term interest rates over the past several weeks.
Prior to the recent volatility, the rise in the well-known Dow and S&P 500 indexes masked a very weak global stock market. Certain stock markets outside of the U.S. are already experiencing bear markets, down more than 20% from their highs.

The well-known U.S. stock market indexes, while setting records during the third quarter, were driven by fewer and fewer rising stocks. Aggressive momentum investing strategies; i.e., buying what has performed best recently, was this year’s ticket to solid performance until recently. As is often the case, those strategies that performed best prior to the recent correction have performed the worst during the correction. As investors, we all must decide whether we want our portfolio to fully participate in aggressive markets or limit losses in weak markets. We simply cannot have it both ways.

Although the economy is strong, we’ve pointed out before that high levels of consumer confidence, low levels of unemployment, and high allocations to stocks by U.S. investors have been reliable predictors of subdued future stock returns.
This seems counterintuitive, but it speaks to human psychology and its effect on risk-taking. Although we all understand the concept of “buying low and selling high,” it is very difficult to do in practice. Most of us are hard-wired to become more optimistic and risk-tolerant when things are going well, and this can lead us to invest more aggressively despite high prices. Conversely, most of us become more worried and risk-averse when things are not going well, and this can cause us to invest more conservatively when prices are low. This is the opposite of buying low and selling high, and we will continue to try to help you resist this temptation.

Past performance does not guarantee future results.  Investment strategies discussed may not be suitable for all investors.  Diversification does not guarantee against investment loss.  The information provided here is for general informational purposes only.  The inclusion of specific securities within the context of broad economic commentary is not intended to be a recommendation.  Investors should thoroughly evaluate any security before taking action.  International investments involve special risks, including currency fluctuations and political and economic instability.  Opinions expressed are subject to change without notice in reaction to shifting market conditions.  Data contained herein is obtained from what are considered reliable sources.  However, its accuracy, completeness or reliability cannot be guaranteed.

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