How a Modern Depression Might Look -- if the U.S. Gets There

How a Modern Depression Might Look -- if the U.S. Gets There
by Justin Lahart
Monday, March 30, 2009


In the wake of the biggest financial shock since 1929, economists say the odds of a depression are less than 50-50 -- though still uncomfortably high. But even if a depression comes to pass, a 21st-century version would look very different from the one 80 years ago.

There is no consensus definition for "depression." Harvard University economist Robert Barro defines it as a decline in per-person economic output or consumption of more than 10%, and puts the odds of a depression at about 20%. Many economic historians say the line between recession and depression is crossed when unemployment rises above 10% and stays there for several years.

The current recession, though severe, is not at depression levels now. Unemployment in February was at 8.1%, not as bad as in the early 1980s -- the last time the idea of a depression was being kicked around seriously, when it remained over 10% for 10 months. In the Great Depression it reached 25%

"When you get an unemployment rate of 25%, it's everywhere," recalls economist Anna Schwartz, who is 94 years old and best known for her analysis of the causes of the Great Depression with the late Milton Friedman. "Everyone is conscious of that and fearful. We're not talking in that league at all."

Using the Barro definition, economists in a Journal poll conducted in early March put the odds of a depression at 15%, on average. But there was wide disagreement. John Lonski, chief economist at Moody's Investors Service, put the depression odds at 30% in early March, but better-than-expected news recently has led him to put it closer to 20%. In contrast, Paul Kasriel of Northern Trust put the odds of a depression at just 1% because of the aggressive lending by the Federal Reserve and the fiscal stimulus just beginning to hit the economy. "There are just too many powerful countercyclical policies in place that will prevent the worst-case scenario," he says.

Today's government response is a far cry from the early 1930s, when the Fed raised interest rates, the infamous Smoot-Hawley Tariff Act crushed trade and Treasury Secretary Andrew Mellon's prescription for the economy was "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate."

"The Great Depression was a mass of policy errors that made it worse," says historian and investment consultant Peter Bernstein, 90. "This time we have our fill of policy errors, but at least they're not making it worse."

Mr. Bernstein lived on Manhattan's Upper West Side during the Depression. "You were conscious of it all the time when you were out in the street," he says. "People looked so threadbare."

The different structure of today's economy means that a modern depression would differ from the Great Depression of the 1930s. Fewer than 2% of Americans working today have agricultural jobs, compared with one in five in 1930. Three-quarters of today's workers are in service-related jobs, which tend to be more stable than manufacturing, compared with fewer than half in 1930.

And then there are the social-safety-net programs that emerged after the Great Depression to blunt the blows. "There were no unemployment insurance, no food stamps, none of the automatic things that maintain some income for people who are out of work," says former Massachusetts Institute of Technology economist Robert Solow, a Nobel laureate. Mr. Solow, 84, grew up in Brooklyn, N.Y., and remembers his parents' constant worry about the next month's money.

With spending on food accounting for a little less than a tenth of a typical family's disposable income today, compared with a little less than a quarter in 1930, a modern depression wouldn't hit people in the stomach as the Great Depression did. Growing up on a Wisconsin farm, Catherine Jotka, 89, remembers taking dried corn meant for animal feed out of the granary and sifting dirt out of it to make corn bread.

Today's cutbacks would be for more discretionary purchases -- cable television, iTunes songs and restaurant meals. And there's plenty of room for trimming, says Victor Goetz, 81, a retired engineer who lives outside Seattle. "This has a whole different feel than anything we had in the 1930s," he says.

Even if the downturn isn't deep enough to be called a depression, the restructuring that it needs to go through means that even after the economy bottoms out, there could be a "lost" four or five years of sluggish growth, says Nobel laureate Paul Samuelson, 93.

As a University of Chicago student during the Depression, Mr. Samuelson remembers attending economic lectures that seemed completely out of step with the times, based on laissez-faire principles that stopped making sense after the 1929 crash. "I was perplexed because I could not reconcile the assignments I got from these great economists with what I heard out the windows and I heard from the street," he says.

Starting in the 1980s, the U.S. saw an extraordinary period of economic quiescence, where growth was steady and policy makers dealt with financial crises handily. Economists began to doubt the possibility of a financial crisis so severe it would upend the economy. And that left them as blindsided as their counterparts when the crisis came 80 years ago.

http://finance.yahoo.com/banking-budgeting/article/106822/How-a-Modern-Depression-Might-Look-if-the-U.S.-Gets-There?sec=topStories&pos=3&asset=TBD&ccode=TBD

Bull market looks premature

Discounting mechanism
By Edward Hadas

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Context News

The Dow Jones Industrial Index has risen 21% since March 9.

The index previously rose 19.2% from November 20 until January 2, before falling 28% until March 9.

The International Monetary Fund predicted global activity to decline by 0.5% to 1% in 2009 and growth to return in 2010, in its economic forecast on March 19.

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Stock markets: All of a sudden, it’s a bull market. The Dow Jones Industrial Index has risen by 21% since March 9, just crossing the traditional 20% threshold that some chart-watchers use to separate a mere rally from the real thing, But this three-week old may not live to a ripe age.

The previous Dow rally started after the November 2008 rescue of Citigroup, lasted until the New Year and came a mere 0.8 percentage points short of qualifying as a bull market – before yielding to a 28% rout. The current recovery has largely been a vote of confidence in a subsequent US banking system rescue, along with massive government help.

Will this upward market movement prove more durable than the last? Mathematically, it has the advantage of starting from a much lower base. From Thursday’s close, the Dow will have to rise a further 14% just to match the 2009 high, hit on January 2.

The economic case is less clear. True, after the nationalisation of financial risk through guarantees and money-printing, panic over a possible imminent financial sector collapse looks overdone. And while GDP in the first quarter of 2009 looks to have been substantially lower than in the fourth quarter of 2008, the pace of decline seems to have slowed.

But the global downward economic momentum remains strong. The International Monetary Fund doesn’t expect growth to return until “the course of 2010”. While waiting, profits are going to be slaughtered.

Profits at non-financial US corporations fell by 9% in 2008. In severe recessions, the average drop is more like 25%, according to BNP Paribas. Globally, the rate at which analysts are cutting their earnings forecasts – a fairly accurate indicator of current profit, according to Société Générale – suggests a 40% decline for quoted companies this year. That suggests investors are paying 20 times current earnings for stocks.

The bull market will only last if it can trample over a thicket of terrible earnings announcements. That is a lot to ask from investors who have not yet fully recovered from a too long series of financial shocks.

edward.hadas@breakingviews.com

http://www.breakingviews.com/2009/03/27/Stock%20markets.aspx?sg=nytimes#

G20 summit stops short of committing the leaders to a new fiscal boost.

A draft communiqué for the G20 summit stops short of committing the leaders to a new fiscal boost. The US and UK had earlier called for other nations to engage in more Keynesian-style stimulus to restore economic growth. Continental European nations, led by Germany, had resisted this.

The communiqué, published by the Financial Times, merely reiterates that the G20 countries have already engaged in “unprecedented and coordinated” fiscal stimulation and says they are “committed to deliver the scale of sustained effort necessary to restore growth while ensuring long-run fiscal sustainability.”

The 24-point communiqué also promises to “resist protectionism and reform our markets and our institutions for the future.”

Meanwhile, President Barack Obama admitted to the FT in an interview that it would be difficult for him to ask for more money to recapitalise the banking system until Wall Street convinces voters it is not misusing the money. “If voters perceive that it’s a one-way street that we are just pouring more and more money into institutions and seeing no return other than avoiding catastrophe, then it is harder to make an argument for further intervention.”


G20 communiqué

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Avoiding Armageddon
By Hugo Dixon


G20: Be thankful for small mercies. The US and the UK aren’t likely to fall out with continental Europe at this week’s G20 summit in London over the fiscal boosts. The draft communiqué promises to do what’s needed to restore growth and ensure long-run fiscal sustainability. But it falls short of calling for any new Keynesian stimulus.

This fudged language is an acceptance of the facts of life. The fiscal stimulation so far, led by the US and China, was probably needed to stop the global economy tumbling into the abyss. But even President Barack Obama doesn’t think he can get Congress to approve another, even more ambitious deficit spending plan, at least not right away.

Gordon Brown, the other neo-Keynesian cheerleader, had a timely reminder last week that states can’t borrow endlessly. The UK prime minister’s aides claimed that the failure of a government bond auction was just a technical glitch. But Brown has learned that investors’ trust in the government’s creditworthiness can no longer be taken for granted.

Obama, Brown and some other leaders might want to try to pump up their economies with another big round of borrow-and-spend. But if the market won’t cooperate, governments would have to have to slam on the brakes, hiking taxes and interest rates in order to stay in business. Such a sudden reversal would create what some people are calling the Armageddon scenario.

One way of avoiding Armageddon is to ensure long-run fiscal sustainability, as the G20 draft puts it. That’s probably the most one can expect from any communiqué. But such platitudes won’t cut much ice with investors. They will want to see credible plans for getting budgets back into balance in the medium term.

Without that, they will fear that governments will go for print-and-spend, a policy that is likely to lead to high inflation. If inflation fears take hold, governments will find it even harder to borrow the mountains of money they need now to finance their deficits.

hugo.dixon@breakingviews.com

http://www.breakingviews.com/2009/03/30/G20.aspx?sg=nytimes#

Health Insurance: What You Need to Know

Health Insurance: What You Need to Know

By LESLEY ALDERMAN
Published: February 2, 2009

With Americans spending an ever increasing amount on medical costs, it’s more important than ever to have insurance that fits your health care needs. So when you start shopping for a plan, don’t just look for one with the lowest premiums. Consider the services that are most important to you.

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The best place to get health insurance, of course, is from your employer. Group plans are typically cheaper, and your employer will probably cover much of the cost.

There are three main types of coverage you can choose from: H.M.O.s (health maintenance organizations), P.P.O.s (preferred provider organizations) and the newer option called an H.D.H.P. (high deductible health plan) paired with a savings account. A small number of companies still offer old-fashioned, fee-for-service plans, but their ranks are dwindling.

Here’s what you need to know about the most common plans:

H.M.O.S provide comprehensive coverage at a low cost to the consumer. In general, you don’t pay any deductibles or co-payments for basic care (and if you do, they will be relatively low). But your choices will be limited. You can generally use only the doctors and hospitals within the H.M.O.’s network, though more plans are easing up on this restriction, and your designated primary-care physician will determine the level of care you require and when you need to see a specialist.
Pros: Low cost. Coordinated care.
Cons: A limited choice of providers. If you go out of network, for example to a specialist, you will probably not be reimbursed.

PREFERRED PROVIDER ORGANIZATION AND POINT OF SERVICE plans were created in response to consumer frustrations with the limitations of H.M.O.s. You can choose to go to network providers and pay a small co-payment, or go out of network and have only a portion — typically around 60 to 70 percent — of your costs reimbursed. The main difference between the two is that a point of service plan requires a referral from your primary care physician to see a specialist, while the preferred provider plan does not.
Pros: More flexibility than an H.M.O.; lower overall out-of-pocket costs than a fee for service plan.
Cons: It’s tricky to predict your costs unless you’re willing to stay within the network. Getting reimbursed for out-of-network claims can be a hassle.

HIGH-DEDUCTIBLE HEALTH PLAN Over the past few years, more employers have begun to offer the option to sign up for a high deductible health plan that is linked to a health savings account or health reimbursement account. Some employers may offer the high-deductible health plan on its own and allow the employees to set up a savings account with the bank of their choice.
The plans work like the preferred provider option, but the deductible is much higher — at least $1,150 for coverage of a single person and $2,300 for families. To compensate for the larger deductible, employers typically offer different two savings options:

• A health savings account allows you to put away pretax dollars and then withdraw the money to pay your out-of-pocket costs. (Your employer may kick in some money, too.) In 2009, you and your employer can put up to a combined limit of $5,950 in a health savings account if you opt for family coverage ($3,000 for singles). The money rolls over from year to year, so you can basically store up a medical emergency fund. When you’re 65, you can take the remaining money out without paying a penalty, though you’ll pay taxes on the withdrawal if you’re not using it to pay for medical costs.
• A health reimbursement account is financed solely by your employer. Typically, an employer will contribute an amount equal to about half the employee’s deductible The money rolls over from year to year, but you cannot take the money with you when you leave the company.

Pros: Low premiums. Tax-free savings (in the case of the health savings account).
Cons: Potentially high costs, especially if you or a family member becomes chronically ill. Don’t choose this option unless you have the money to pay the deductible.

INDEMNITY, OR FEE-FOR-SERVICE, PLANS are offered by fewer and fewer employers because of their expense. They allow you to go to any doctor, hospital or medical provider you choose. The plan typically reimburses 80 percent of your out-of-pocket costs after you fulfill an annual deductible.
Pros: Flexibility. You can go to any medical provider, anywhere, without seeking plan approval first.
Cons: Your total out-of-pocket costs will probably be higher than in a preferred provider plan or H.M.O. Most fee-for-service plans don’t cover preventive care like flu shots or mental health services.

To help narrow your choice, here are the steps you should take:
1. Ask your favorite doctors which insurance plans they accept. If you find that one or more of your doctors do not accept any insurance plans, then you’ll want to select a plan that reimburses you for your costs when you go out of the network.
2. Make a list of all the services you and your family use. Include on the list things like vision care, dental, physical therapy, acupuncture and mental health care. Find out how the plans you like best will cover these services and at what cost.
3. Compare costs. Write down the costs associated with each plan, including premiums, out-of-network costs, and extras like vision or mental health care.

The Joint Commission on the Accreditation of Healthcare Organizations has put together a comprehensive list of helpful questions.

In addition to offering low-cost health insurance, your employer may also offer a health care flexible spending account, which lets you set aside pretax dollars to pay for your out-of-pocket medical costs. (If you have already signed up for a health savings account, you can only use the flexible spending account for dental, vision or post-deductible medical expenses.) You can deposit up to $5,000 a year in a flexible spending account, depending on the limit set by your employer. The money will be deducted from your paycheck and you can’t change the amount midyear. If you have high medical costs, using a flexible spending account can save you hundreds of dollars a year in taxes. But calculate your costs carefully. The money does not roll over to the next year. Any money you don’t use will be lost.

If you need to buy insurance on your own — there are a number of options to consider, including these:

First, if you are about to lose your job and work for a company with more than 20 employees, you can remain on your employer’s plan for up to 18 months, under a federal law called Cobra, the Consolidated Omnibus Budget Reconciliation Act. But you will have to pay the full premium plus 2 percent for administrative costs, and the expense is often quite high. This may be a good temporary measure, though, until you can find a more affordable option.

If you’re out on your own, try to find a group plan to join since group plans typically cost less and offer more benefits than individual plans. Can you join your spouse’s plan? Do you belong to (or can you join) a union, professional organization or alumni group that offers insurance? You may also be able to find a group plan for freelance workers. If you are over age 50, look at the plans offered by the AARP.

If a group plan is not an option for you, you’ll have to buy an independent policy. Fortunately, there are numerous plans to consider. The simplest way to compare policies and prices is by going to an online insurance broker like eHealthInsurance.com. At EHealthInsurance, for instance, you simply fill in your gender, ZIP code and date of birth -- and, if you want, the names of your doctors — and the site comes up with a list of policies for you to consider. You can apply online.

If the prospect of sorting and sifting through dozens of policies seems daunting, consider using an independent insurance agent, who sells many different kinds of health insurance. You can find agents in your area at the Web site for the Independent Insurance Agents & Brokers of America.
Individuals with modest incomes may be eligible for Medicaid. You may be able to get coverage for your children through the State Children’s Health Insurance Program, a federal-state partnership.

If you have a serious health problem and are unable to find coverage through a private insurer, find out whether your state has a high-risk pool that you can join. While these plans are not low in cost, they are often the only option for people with pre-existing conditions.

http://www.nytimes.com/2009/02/03/your-money/health-insurance/primerhealth.html?em=&pagewanted=all

Helping Out With Cash: A Delicate Art

Your Money
Helping Out With Cash: A Delicate Art

comments (39)
By RON LIEBER
Published: March 27, 2009

It was the idea of her friend’s children riding around in the back seat of an uninsured vehicle that finally convinced Mishiko Flores that she had to do something to help.

Q. & A.
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First, she asked her husband: Could they afford to give the family money? Then, she practiced her offer with her mother. In the end, Ms. Flores made a delicate approach and, after bursting into tears, her friend accepted the $3,000 gift.

In last week’s Your Money column, I asked readers to tell me how they were wrestling with the question of whether to give — or take — money from those closest to them. The responses poured in from people like Ms. Flores who have offered help and those who have been recipients of financial aid, or who wish they were.

Because so much attention has been on the shortcomings of government assistance, I had not realized how many people were grappling privately with how best to reach out. Still, the volume of replies shouldn’t have been surprising, given that so many people have lost jobs, lost money in investments and watched the value of their houses drop in the past year or so.

And for all the people who are struggling to pay the bills, there are many in their inner circle who have been agonizing for months over how or whether to write them a check.

You can read some of the scores of inspiring (and dispiriting) reader comments on the Web version of last week’s column. We’ve also sorted some of the most thoughtful e-mail replies by topic in an interactive viewer linked from the version of this column at nytimes.com/yourmoney.

Meanwhile, I’ve tackled five of the toughest parts of this money quandary below.

GRANT OR LOAN? Whether you give money outright to those closest to you or lend it, the dangers are similar. Putting money between you can fundamentally and permanently alter the nature of the bond.

Loans are particularly problematic. Debt, especially when it is piled on top of existing loans, adds to uncertainty, especially if the recipients have no idea when they are going to be able to pay it back.

Giving money to someone you know, meanwhile, requires a specific mind-set. Can you truly do it without any expectations or preconditions? And can you do it without resenting what the recipient chooses to do with it?

“The person who is unemployed wants to be sure there are no strings attached,” said Fred Bracken, a New York City resident who recently lost his job with American Express. “There’s a difference between lending a hand and being coddled.”

If there are conditions, make them simple rules that inspire everyone involved. Almost 50 years ago, Rich Wilbanks was moving from Oregon to California with his family so he could start a teaching job. His brother and his wife handed them $300 and told them it was in the nature of a loan but that they would need to repay it by helping someone else.

He and his wife have paid it forward many times over the years since. “You get to pay what you want to whom you want,” said Mr. Wilbanks, who is now retired and living in Berkeley. “You never get a statement about it. It’s your obligation to deal with yourself, somehow down the road somewhere.”

Ms. Flores, the Clifton, N.J., resident who helped her friend, added two other items to the script. First, Ms. Flores reminded her friend that she would certainly do the same thing for Ms. Flores’s family if the need arose. And then, she told her friend that she never wanted to talk about it again.

One year later, the relationship is still intact.

ASK FIRST, OR JUST ACT? It is tempting to offer financial aid only when someone close to you asks. After all, you don’t want to embarrass anyone. But it may be best to risk discomfort, or being turned down, in the event that the person you’re worried about is simply too proud to make the request.

Ms. Flores, who counsels New Jersey state prisoners for a living, said, “A lot of the time, I’ll deal with clients who get into trouble because they’re afraid to ask for help.”

Even when someone does not accept an offer, the act of asking can itself be helpful.

“Just the thought that there is help in the margins means you don’t necessarily have to take it, and that has sustained me,” said Naomi L. Maloney, a copywriter and brand consulting strategist in Oakland, Calif., whose friends have offered her loans. “It makes me work a little bit harder and feel more confident in my self-worth as a worker and as an earner, to know that the help is there if I need it.”

ACT ALONE OR WITH OTHERS? In late January, Steven Roy lost his job, which provided health insurance for his family. A few weeks later, his infant son Isaac, who is known as Ike, was found to have a life-threatening illness. Within hours, friends of the family from the AustinMama Web community in Texas had erected ikeasaurus.com to coordinate help for the family. A few hours later, there was $4,000 in a PayPal account with the Roys’ name on it.

Kari Anne Roy, Ike’s mother, said it was easier to accept the money from a group than it might have been to say “yes” to many individuals. “There is no one we could give the money back to,” she said, given that the money in the PayPal account, now up to about $8,000, is a single sum. “We couldn’t give it back if we tried.”

That said, accepting the money, which the family has barely begun to spend and still hopes not to, has not been easy. “I don’t want to be that family on the tip jar at the sandwich store,” she said. “I feel an overwhelming sense of responsibility. Is it O.K. to buy bottles with the money, or do I need to buy medicine instead?”

GIVE ANONYMOUSLY? If you want to give money but handling it face to face is not palatable for whatever reason, anonymous grants are another option. If you are part of a religious congregation, its leader may be willing to help with the gift.

Sue Barnet of Wetumpka, Ala., arrived home one day in November to find a $200 check in the mail. The bookstore where she worked had closed, and someone from her church had given the money anonymously to her minister and asked that he forward it.

Ms. Barnet said she was so amazed that she had to sit down at her kitchen table.

“I couldn’t believe that someone in our congregation thought enough of me and had enough faith in me that they decided to do something really practical to help,” she said. “I come from a family of extraordinarily independent women, very determined. Sometimes that’s not such a good thing. I think I would have just been too embarrassed to accept a direct gift.”

Thanks to a new part-time job at a public library, Ms. Barnet is beginning to recover financially. She said she planned to donate to her church’s discretionary fund, which her minister could use to help others in need.

Another way to hide your identity while giving is through the Giving Anonymously Web site, givinganon.org. The nonprofit group will send an anonymous check on your behalf and record thank-you messages from the recipient.

CASH OR DIRECT PAYMENT? As a general rule, plain money is the most flexible gift there is. There are no limits on its use, as there is with a gift card.

If you can’t spare money right now, giving frequent-flier miles to people who might not otherwise be able to afford a vacation or a trip to attend a funeral is a nice gesture.

Several people wrote in to suggest one final idea: giving to the children of adults facing financial distress. Paying the provider directly for a music lesson or a week of camp feels less like an act of charity and has the added benefit of allowing those who disapprove of the parents’ spending or other choices to keep their children from doing without.



http://www.nytimes.com/2009/03/28/your-money/28money.html?em

Lowered Expectations for the Bulls’ Return

Fundamentally
Lowered Expectations for the Bulls’ Return

By PAUL J. LIM
Published: March 21, 2009

THROUGHOUT the 1980s and ’90s, investors took comfort in knowing that short-term setbacks were just that: short. Back then, it took only about a year and a half, on average, for stocks in a bear market to slide from peak to trough and then climb all the way back.

Jeremy Grantham of the investment firm GMO says a roaring bull market is possible, “but it may still take us 10 years” to return to the previous peak.

But this is a different era. The downturn, which cut the Dow Jones industrial average in half, is already nearly a year and a half old, and despite recent gains there’s no clear sense that the worst is over.

So it’s time for investors to reset their expectations, many market strategists say. At the very least, don’t count on the market normalizing, or “reverting to the mean,” with much speed. And don’t count on the market recouping all its losses for several more years.

Setting aside specific problems now facing the economy — like the credit crisis and the continuing troubles in the housing and financial sectors — the math of recovering from downturns of this magnitude is hard to overcome quickly. James B. Stack, editor of the InvesTech Market Analyst, a newsletter in Whitefish, Mont., studied bear market recoveries since 1929; he found that after the most significant downturns — like this one — it has taken more than seven years for stocks to fully recoup losses.

For example, it took 7.2 years after the start of the bear market in 2000 for stocks to reach a bottom and then to climb back to the 2000 peak. After the bear started growling in 1973, it took 7.5 years to return to the high. And after the 1929 crash, equities didn’t return to their previous peak for another quarter of a century.

The current bear market started on Oct. 9, 2007. Based on the average recoveries of the past, the Dow may not make it all the way back to its peak of 14,164 until late 2014. And some market observers say it could take significantly longer.

But don’t stocks usually bounce aggressively off their lows? And aren’t stocks supposed to perform much better than average after years when they perform much worse than average?

Maybe not. A recent report by Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School found that the payoff for investing in stocks following bad years was only slightly better than after good ones.

The report looked at global stock market performance going back to 1910. In five-year periods after the worst years in the market, stocks returned 7.1 percentage points above the prevailing yield on a three-month Treasury bill. Following the best years, stocks gained 6.8 points above cash. The study was part of the 2009 Credit Suisse Global Investment Returns Yearbook.

“Betting on quick mean reversion is a dangerous thing,” Professor Dimson said.

But assume for a moment that the market is due for a big snap-back. Even if that were to occur, stocks would still have a steep mountain to climb.

“We could have a legendary run off the lows, but it may still take us 10 years to get back to our old highs,” said Jeremy Grantham, chairman of the investment management firm GMO.

Historically, bull markets have gained around 38 percent in their first 12 months. That amounts to more than a third of the total gains throughout a typical bull market’s life. Let’s assume that such an initial surge happens this time.

The Dow is trading 7,278. A 38 percent rise would lift the Dow to 10,043. Even assuming a 10 percent annual climb thereafter — a big assumption in tough times — it would take nearly four more years to get back to even. That would bring us to 2013.

Investors who bank on 10-percent-plus returns may be fooling themselves, says Robert D. Arnott, chairman of the investment management firm Research Affiliates. “The folks who are thinking that we could go back to a sustained period of double-digit annual returns for stocks haven’t really studied their history,” he said.

Based on long-term returns of the Standard & Poor’s 500-stock index, including dividends, Mr. Arnott said it was reasonable to expect that stocks might generate annual returns of around 8.5 percent.

IN the 1990s, he noted, earnings growth was higher than average. That, as well as investors’ willingness to pay higher prices for each dollar of earnings, accounted for the outsize market gains in that decade, he said.

But that kind of euphoria about stocks will probably not be repeated anytime soon, as price-to-earnings ratios for stocks have fallen back in line with their historical norms and are well below their recent highs. “We have to move people away from the mind-set that anything less than double-digit returns is disappointing,” Mr. Arnott said.

Here’s another way to think about it: Even if it takes 10 years for the Dow to claw back to its old highs, at an annual rate of nearly 7 percent, “you would have still done very well — certainly better than in T-bills,” Mr. Dimson said.

Single-digit stock returns may not seem all that thrilling, compared with the huge numbers posted during the bull market of the ’90s. But for many investors, a stretch of modest returns might be a great relief after the losses of the last few years.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.

http://www.nytimes.com/2009/03/22/your-money/22fund.html?em

Now the Long Run Looks Riskier, Too

Strategies
Now the Long Run Looks Riskier, Too

By MARK HULBERT
Published: March 28, 2009

CAN investors count on the stock market to produce handsome long-term returns?

The conventional answer has been, emphatically, yes. After all, despite downturns like the one we’ve endured recently, stocks over periods of 30 or more years have almost always outperformed other asset classes. And numerous studies have found that the stock market’s long-term returns have tended to fall within a surprisingly narrow range.

But those studies were based on the stock market’s past performance, which, famously, provides no guarantee of future performance. New research, using different statistical techniques aimed at capturing the uncertainty of future returns, suggests that the market may be much riskier than many investors have understood.

The new study, which began circulating last month as a working paper, is titled “Are Stocks Really Less Volatile in the Long Run?” Its authors are Lubos Pastor, a finance professor at the University of Chicago Booth School of Business, and Robert F. Stambaugh, a finance professor at the Wharton School of the University of Pennsylvania. A copy is at http://ssrn.com/abstract=1136847.

The professors don’t disagree that, historically, the stock market’s returns over various 30-year periods have been surprisingly consistent. Periods of particularly good returns have been followed by subpar ones, and vice versa — a process that statisticians call reversion to the mean. Prof. Jeremy Siegel, also of Wharton, and the author of “Stocks for the Long Run,” is often credited with demonstrating that mean reversion has been at work in the American stock market since 1802.

In an interview, Professor Stambaugh said that while Professor Siegel’s research shows that mean reversion is powerful, it is hardly the only force affecting the stock market’s long-term returns. Because estimates of those other forces are imprecise, Professor Stambaugh said, uncertainty about market fluctuations increases with the holding period — the opposite of what happens because of mean reversion.

One example of such a force, Professor Stambaugh said, is global warming. Its impact on the economy over the next 12 months is likely to be quite small, he said. But expand the horizon to the next several decades, and the possible effects of global warming range from negligible to catastrophic.

It is one thing to acknowledge the existence of uncertainty, but quite another to measure its influence on long-term market volatility. To do that, Professors Pastor and Stambaugh rely on a statistical approach pioneered by the Rev. Thomas Bayes, an 18th-century English mathematician. Bayesian analysis is often used to assess the uncertainty of future outcomes, based on a formula for updating the probabilities of given events in light of new evidence. This approach is quite different from traditional statistical measurements of probabilities based on historical data.

Applying Bayesian techniques, the professors found that reversion to the mean isn’t powerful enough to overcome the growing uncertainty caused by other factors as the holding period grows. Specifically, they estimated that the volatility of stock market returns at the 30-year horizon is nearly one and a half times the volatility at the one-year horizon.

Why don’t traditional measures of volatility, such as standard deviation, pick up this phenomenon? Those measures focus only on how much the stock market’s shorter-term returns fluctuate around the long-term average, Professor Stambaugh says.

As a result, they ignore uncertainty about what the average return might itself turn out to be. For example, he said, it is possible that the standard deviation of the market’s returns over the next 30 years could end up the same whether its average annual return over that period is 20 percent or zero.

What about Professor Siegel’s finding that the stock market has produced an annual average inflation-adjusted return of close to 7 percent since 1802? In an interview, Professor Pastor emphasized that the last two centuries could easily have been less hospitable to the United States, most likely lowering the stock market’s returns. An investor couldn’t have known in advance that the United States would win two world wars, for example, or emerge victorious from the cold war. In any case, he said, there is no guarantee that the next two centuries will be as kind to the domestic equity market as the last two.

IN an e-mail message, Professor Siegel acknowledged the theoretical uncertainty of forecasting stock market returns, but said it was hard to quantify it. He said the methods that Professors Pastor and Stambaugh used to measure the uncertainty were “very much outside of the standard statistical techniques.”

But Professor Pastor says that these methods are better suited than the standard techniques for quantifying the uncertainty faced by real-world investors. Even if Bayesian approaches have yet to become mainstream in financial research, he adds, they have become much more widely used in recent years.

What is the investment implication of the new study? Other things being equal, Professor Stambaugh says, you would probably lower your portfolio allocation to stocks. But by how much? It’s impossible to generalize, since the answer depends on your time horizon and what else is in your portfolio.

Mark Hulbert is editor of The Hulbert Financial Digest, a service of MarketWatch. E-mail: strategy@nytimes.com.


http://www.nytimes.com/2009/03/29/your-money/stocks-and-bonds/29stra.html?_r=1&em

Buy China, emerging markets over 2 years, Marc Faber says

Buy China, emerging markets over 2 years, Marc Faber says
Monday, 16 March 2009 13:56

CHINA AND OTHER emerging markets offer value over the next two years as growth picks up, investor Marc Faber said.

Investors should buy stocks and other assets in China after the market falls to its 2008 low to profit from an expected recovery, Faber said in an interview with Bloomberg Television. China is the world’s best-performing stock market this year.

“Rapidly growing countries have setbacks from time to time,” Faber, the publisher of the Gloom, Boom & Doom report, said in Hong Kong. “I think we’re going to test the lows again, but over the next two years, it’s probably a good time to invest.”

The MSCI World Index has retreated 18% this year, extending last year’s record 42% slump, amid concern the widening financial crisis and global recession will sap corporate profits. The Shanghai Composite Index, which tracks the larger of China’s two mainland exchanges, has gained 16% in 2009.

China is betting that a 4 trillion yuan ($900 billion) stimulus package and interest-rate cuts will help it reach its 8% growth target this year. The global economy is expected to expand at a 0.5% expansion, according to the International Monetary Fund.

Industrial and precious metals are attractive investments after the Reuters/Jefferies CRB Index of 19 commodities “collapsed,” Faber added. The CRB Index has dropped 8% this year, adding to the 36% retreat in 2008.

“Asset markets have already discounted a lot of the bad economic news,” he said. “ Some assets like commodities are very, very inexpensive.”

Faber had advised buying gold at the start of its eight-year rally, when it traded for less than US$300 an ounce. The metal topped US$1,000 last year and traded at US$932.78 an ounce today. He also told investors to bail out of US stocks a week before the so-called Black Monday crash in 1987, according to his website.

He continues to favour gold, which has gained 19% in the past six months because currencies including the US dollar are “not desirable”.

Stock markets are “not particularly expensive” and investors should consider buying them in anticipation of a recovery, Faber advised. The MSCI global index is valued at 11 times reported earnings, half its 10-year average multiple of 22.

“We also have a lot of equities that are not particularly expensive because they’ve collapsed,” Faber said. “These are relatively sound companies and whenever the recovery will come, they will be in a strong position.”



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Will the G20 meeting help resolve the crisis?

Will the G20 meeting help resolve the crisis?
Saturday, 21 March 2009 23:23


THE G20, REPRESENTING 20 of the world’s most influential economies, is to hold a summit meeting early next month. There have been intensive preparations for this summit and hopes have been raised in financial markets that joint international action will be taken to halt the spread of the crisis and lay the foundations of recovery. Our view is that internationally co-ordinated policies are a vital part of the policies needed to bring this crisis to an end but investors should be realistic about what can be achieved at such international summits.


WHY INTERNATIONALLY CO-ORDINATED POLICIES ARE VITAL
The current global slowdown is the worst we have seen since the post-World War II global economic order was established in 1945. Moreover, the global crisis is unprecedented in the speed of the economic declines many countries are suffering, its geographic spread and the complexity of understanding and resolving its roots because of the new-fangled financial innovations which lie at the heart of the crisis. The scale and global nature of the crisis alone calls for joint action but there are other reasons why coordinated actions are needed to resolve the crisis:

First, substantial amounts of monetary stimulus are needed to kickstart a recovery. Yet, if some countries are far more aggressive in this area than others, then any recovery could be thrown off-track by currency turmoil. For example, if the US is prepared to literally print money to ease its way out of the crisis but the European Central Bank is not, then at some point, holders of US dollar assets are likely to lose confidence in the dollar and switch to the euro. Already, the Chinese — now the world’s largest holders of US dollar securities — have signalled their discomfort with the risks associated with the US dollar. Premier Wen Jiabao noted in an important speech to the National People’s Congress recently that he was quite “worried” about China’s investments in the US dollar.

Related to this is the fact that so far policy makers have not used one monetary tool that could prove to be highly potent — getting the International Monetary Fund (IMF) to issue new Special Drawing Rights(SDRs). The latter are a form of global money which the IMF, acting as a sort of global central bank, is allowed by its statutes to issue. Technically, if 85% of IMF voting shares opt to do so, the IMF can simply “print money” by allocating each IMF member country with new SDRs. For the past 30 years though, the US has opposed such SDR issues. It will require a highlevel agreement among the world’s top economies to allow an SDR issue to materialise, something which could be a strong positive for the world economy.

Second, the global crisis is widening. Several countries in eastern Europe stand on the brink of a crisis that could be as bad for them as the Asian financial crisis was bad for this part of the world. Hungary — one of the countries at risk — has estimated that US$230 billion ($350.5 billion) worth of aid is needed to contain this threat. Such massive rescue packages can only happen if there is joint agreement to share the burden of such aid.

Third, an important reason why trade flows have collapsed so precipitately is the disruption in trade finance. So far, individual or bilateral efforts to get trade finance flowing again have not worked. Here, too, international co-operation is crucial.

Fourth, we need global agreement on avoiding mutually damaging actions, of which two are critical:

There are increasing signs that, despite all the rhetoric about preserving world trade, many countries are resorting to disguised forms of trade distortion to protect their producers. If there is no firm resolve to prevent this spreading, we could still see the breakdown of free trade which most people agree is important to maintain global economic growth.

There is also a temptation for some countries to engage in competitive devaluations. Again, joint agreement is needed if to avoid this.


DON'T HOLD YOUR BREATH
So, can the G20 economic co-operation process deliver the results we want? Here is where we cannot be fully confident. There are several reasons why we need to be cautious.

First, the structure of the G20 is not amenable to quick decision-making. While it is supposed to be restricted to just 20 countries sitting around the table, in reality, the number of actual participants has soared in recent weeks. For example, while Indonesia is the Asean member in the G20, Thailand as the chairman of the Asean summit this year will reportedly be there to represent Asean. Similarly, other countries are being added, as are several international agencies. We understand there might now be 48 people sitting around the table, not just 20. That size does not make for easy or quick decision-making.

Second, there are fundamental disagreements which can at best be papered over, not fully resolved. We saw this with the recently concluded G20 finance ministers’ meeting. While the US was keen to secure agreement among all nations there for aggressive fiscal pump priming, there was not sufficient consensus on this, forcing the Americans to drop their demand that all countries commit themselves to fiscal stimulus equivalent to at least 2% of GDP.

Nevertheless, the G20 process is still useful. Bringing together key world leaders in this format will help ensure that some governments do not follow through with mutually damaging policies. So long as all these countries see themselves as having a stake in the G20 process they are bound to avoid the trade-destroying policies that led to the Great Depression of the 1930s. Not only will the G20 process help avoid bad policies, the sharing of experiences at such meetings can also help individual countries craft solutions to their national problems by learning from others.

Moreover, only such gatherings of a large number of countries can secure agreement on the way forward on some key areas — such as the expanded resources to be given to the IMF and other multilateral agencies such as the Asian Development Bank, an agreement that was the product of the G20 finance ministers’ meeting.

So, what is the bottom line? The good news is that multilateralism is alive — so we can almost certainly avoid the foolish mistakes of the past such as blatant protectionism. The bad news is that the decision-making process will not be speedy and that means that the bottom to the crisis is still some way off.

Manu Bhaskaran is a partner and member of the board of Centennial Group Inc, an economics consultancy

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British property not quite a bargain yet

British property not quite a bargain yet
Saturday, 21 March 2009 23:36

“YOU REALLY SHOULD buy a property in London if you’ve got some spare cash; they’re going for a song!” a Londoner friend said recently. Indeed, after years of a property boom that saw prices triple, the UK housing market has crashed following the global credit crunch, with average house prices having fallen about 20% from their peak and the bottom of the market yet to be seen.


Anecdotes of prices of some central London properties plunging 50% — estate agent Hamptons International cites a London property worth £1million in December 2007 going for £470,000 in January 2009 — have attracted interest from investors, particularly foreign buyers drawn by bargain prices and a weak sterling. Recent figures from Hamptons reveal that properties in prime central London saw a 20% increase in European buyers in 4Q2008 y-o-y, while 12% more European and American investors registered to purchase property in the rest of the country.

Foreign interest has resulted in some central London property prices bucking the trend. According to property website Primelocation.com, prices in Mayfair and Knightsbridge rose for the fourth consecutive month in February by 0.94%, compared with the 0.56% fall in southeast London and 1.83% drop in southwest London.

Investors should, however, be aware that there may be further downside. Analysts warn that prices are set to fall further as they have yet to reach their fair value. Comparing total house prices with economic output, RAB Capital’s Dhaval Joshi said in The Observer that house prices will need to fall by another 15% before they are fairly valued. MoneyWeek reports that the UK house price-to-earnings ratio is currently 4.8, compared with the long-run trend of between 3.5 and four times, and that prices should fall another 17% to 39% before hitting fair value. Numis Securities, however, thinks house prices could fall by as much as another 55% if the market over-corrects itself to the same extent as during the 1990s recession. It’s a scary figure but highly possible, given the worsening economic outlook.

UK housing sales have remained at their lowest level since 1978, with an average of 9.5 transactions per agency over the three months to February, according to the Royal Institution of Chartered Surveyors (RICS)’s latest UK housing market survey. The Guardian reports that London agents are experiencing the worst transaction levels, with only six properties sold per agency over the three months to February.

The slowdown in transactions, however, is not due to a lack of demand. The RICS survey found that new-buyer inquiries in London jumped to a two-year high in February, as chartered surveyors reported a 44% rise in new-buyer inquiries, up from 25% in January. There is, apparently, strong interest nationwide, particularly in London and the south of England. Some analysts, however, see this as just “window shopping”, and do not foresee these inquiries leading to a marked rise in actual sales any time soon.

The reason for poor sales is the lack of funding, as the availability of mortgages tightens due to the credit crunch and first time buyers struggle to cough up the higher deposit or downpayment required — this now averages 25% of the property price, a long way from the 0% to 5% during the good times.

The current rate of mortgage approvals is still less than half of what it was a year ago, even if it has levelled out to an average of 31,000 a month for the past six months, as reported by the BBC. Last week’s indications that the Financial Services Authority may consider limiting the size of home loans in future to protect people from borrowing too much will certainly not help matters.

Grim unemployment figures — Office for National Statistics data revealed last week that unemployment has risen to its highest level in 12 years with nearly 2.03 million jobless in the three months to January — also means that would-be buyers concerned about their jobs will be reluctant to commit to a house purchase. Expectations of a further fall in prices are also holding back buyers; as Guardian Money editor Patrick Collinson said in his housing price blog recently, no one in their right mind would sink their life savings into a property if they felt it was about to drop 20% in value.

Anecdotal evidence suggests the contrary in some situations, however. Location will always matter, as well as a lack of supply. A house-hunting friend in Cambridge recounts situations where several of her offers for family homes were quickly outbid. The offers were for homes in a village location near good schools: Very few such properties ever come up in the market.

In the meantime, investors eyeing lucrative rentals should watch out for falling rental rates in London, where the top-end rental property market has been hard hit by cutbacks on employees’ rental allowance and by an exodus of financial expats from the City. According to Primelocation.com, prime London letting prices have fallen for the 11th consecutive month in February, registering 13.7% lower than the same time last year. Stock levels are up 97% on last year, as house sellers unable to secure a good price resort to renting out their properties instead. More and more of these “unplandlords” are expected to enter the market as the property sales market is not expected to bounce back any time soon, adds property expert Sarah Beeny in the Evening Standard.

Investors with spare cash would do well to tread carefully and do their homework before responding to the siren call of bargain British property.

Lim Yin Foong was editor of Personal Money, a Malaysian personal finance magazine published by The Edge Communications, from 2001 to 2006. She is currently based in the UK.

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Safety and Risk: How do you define a perfect investment?

Millions buy stocks, bonds, or mutual funds, purchase real estate, or make similar investments. They all have reasons for investing their money. Some people want to supplement their retirement income when they reach age 65, while others want to become millionaires before age 40. Although each investor may have specific, individual goals for investing, all investors must consider a number of factors before choosing an investment alternative.

Safety and Risk

How do you define a perfect investment?

For most people, the perfect investment is one with no risk and above average returns. Unfortunately, the perfect investment does not exist, because of the relationship between safety and risk. The safety and risk factors are two sides of the same coin. Safety in an investment means minimal risk of loss. On the other hand, risk in an investment means a measure of uncertainty about the outcome.

Investments range from very safe to very risky.

At one end of the investment spectrum are very safe investments that attract conservative investors. Investments in this category include government bonds, certificates of deposit, and certain stocks, mutual funds, and corporate bonds. Real estate may also sometimes be very safe invesment.

At the other end of the investment spectrum are speculative investments. A speculative investment is a high-risk investment made in the hope of earning a relatively large profit in a short time. Such investments offer the possibility of larger dollar returns, but if they are unsuccessful, you may lose most or all of your initial investment. Speculative stocks, certain bonds, some mutual funds, some real estate, commodities, options, precious metals, precious stones, and collectibles are high-risk investments.

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Secrets of the ultra wealthy

2008/06/28

Business: Secrets of the ultra wealthy


MOST of personal finance books share the methods and approaches that you can use to manage wealth of average person.

If you happen to own more than average wealth or have more complex needs, you may not find all your answers in those books.

The book, Family Office: The Super Rich's Secret to Wealth Maximisation, shares with you the wealth management approach (Family Office) that was once the exclusive domain of ultra wealthy individuals and families in the world.

Family office is a physical office that is set up to manage the financial affairs of one family or more.

If the family office operates on a larger scale and caters for extremely wealthy families, it may be staffed by accountants, lawyers, investment advisers, bookkeepers, tax specialists, real estate specialists and even art curators.

John D. Rockefeller, Bill Gates, Michael Dell and many other super-rich have a dedicated family office to manage their personal wealth.

As a trusted adviser to some of Malaysia's richest entrepreneurs and chief executive officer for more than 10 years, Yap Ming Hui is a right person to write this book. He is the founder and managing director of Whitman Independent Advisors Sdn Bhd, a boutique firm that provides financial advisory services to high-net worth individuals and families in Malaysia.

Yap has had columns in the newspapers and has also written several books, including You Can't Manage Your Money ... Especially When You're Rich, Maximise What You've Got ... No Matter How Much You Have Now and MaxWealth: How To Maximise Your Wealth Beyond Investment Returns.

As the first book in Malaysia on the subject of family office, the book covers almost everything you need to know on the subject.

In addition to concepts and theories, this book also shares real-life examples of how different families in West have used family office to preserve and maximise their wealth for generations.

This book provides a good introduction to family office for those who are new to the concept. Readers will find it easy to relate as the author has used many Malaysian or Asian real life stories to illustrate his points.

This book is different from most personal finance book that teaches you how to make money and create wealth. It focuses on how to preserve and maximise the wealth that you have created.

Therefore, this book is a must-read for those who have worked hard to accumulate their wealth. Many wealthy families in Malaysia and Asia will be able to break the curse of "wealth doesn't last three generations" if they were to read and apply the ideas in the book.

Family Office is priced at RM49.90 and is available at all major bookstores.

http://www.nst.com.my/Current_News/NST/Sunday/Focus/2278689/Article

Family planning hinges on financial stability

Your Money: Family planning hinges on financial stability
By Yap Ming Hui

2008/11/01

AS a financial planner, I have seen many clients’ financial planning position greatly influenced by their family planning, that is, having children: how many, how frequent, how early and so on. Some clients plan the family carefully to match their financial planning. There are some whose financial planning position suffered due to their poor or lack of family planning.

In this article, I will look into the various aspects of family planning and how they affect one’s financial position.

How many children to have? There are some who love children; the more the merrier. Some of them talk about having as many as six children. The financial planning implications of having more children are obvious. The more children you have, the more financial resources need to be allocated to address their needs.

Nowadays, raising a child is not cheap. The expenses, other than feeding, include healthcare, medical expenses, pre-school mental development, clothing, private school fees, tuition fees, hobbies and leisure and many others.

As a result, more financial resources must be allocated for children’s maintenance and education. Hence you have less resources for other financial objectives, especially for your retirement planning.

Alternatively, you may limit your financial allocation for the children. Then, the financial resources allocated for each child would be diluted.

The third alternative is to work harder to accumulate more money.

Those who have more children would enjoy a merrier family life. This is especially important when one gets older. The atmosphere during festive occasion is much merrier with six children compared with one. You can also expect more financial support when you are retired, if necessary.

For those who choose to have a small family, you can channel more financial resources to your children.

The rule of the game is quality rather than quantity. At the same time, you can expect less financial burden from your children. However, you must be prepared to live a retirement life with less children for company.

How frequent to have children? Some people prefer to have children close to each other so the age difference between the children is small. Some would prefer to space out their children. There are advantages and disadvantages for both types of family planning.

In the first case, the couple have the advantage of finishing their duty as parents early.

For example, if you are married at the age of 28 and have your first child at 29, second at 30 and the third at 31, by the time your first child is 18 and ready to go to tertiary education, you are 47.

If he or she takes four year to complete the tertiary education, you will be 51 by the time your first child graduates from college and may not financially be dependent on you anymore.

By the time your last child reaches 18, you will be 49.

When the child graduates, you are only 53.

As a result, such a family planning allows you to enjoy your retirement with peace of mind. You do not have to worry about the cash flow needed to support your children’s tertiary education when you stop earning active income.

But everything comes with a price. This type of family planning will relatively give you more financial stress.

From financial planning point of view, you would have three series of cash flow overlapping each other.

Using the example of tertiary education expenses that stretch over a period of four years, by the time your third child enters college, your first and second child is still in college.

If each of the child’s annual tertiary education expenses is RM50,000, then you would have a total of RM150,000 (3 child x RM50,000) cash flow needs to meet in that year.

If you intend to have such family planning, it is important that you are aware and prepared for such financial challenges.

In the case of a couple planning to have their children’s age relatively farther, they have the advantage of performing their duty as parents in a less stressful manner.

For example, you are married at the age of 28. If you have your first child at 29, second at 33 and the third at 37, then by the time your first child is 18 and ready for tertiary education, you are 47.

You would be 51 by the time your first child graduates from college.

Your second child will only enter the college after your first child has graduated from the college and is not financially dependent on you.

Your second child will graduate when you are 55.

Only then your third child would start his or her tertiary education. By having this type of financial planning, you can space out your cash flow need so that it does not overlap each oth e r.

If your budget for each child’s annual tertiary education expense is RM50,000, you only need to plan for a cash flow need of RM50,000 in a year instead of RM150,000 as in the first scenario.

However, this type of family planning would require you to continue financing the children’s tertiary education expenses after 55. Using the same example, your third child would only complete his or her education when you are 58.

If you stop earning active income after 55, you will still need to worry about financial sources to fund the child’s education. As a result, you may not have complete peace of mind even though your have retired.

There is no perfect family planning from financial planning point of view. There are advantages and disadvantages under various alternatives. It is important for you to be aware of the different financial planning implications for different family planning.

You must search your soul and ask yourself which scenario you are comfortable with.

The worst case is letting your family planning take its natural course and not knowing its implications on your financial planning.


--------------------------------------------------------------------------------
© Copyright 2009 The New Straits Times Press (M) Berhad. All rights reserved.


http://www.nst.com.my/Current_News/NST/Sunday/Focus/20081101214646/Article/pppull_index_html

Making the correct assumptions

NST Online » Focus
2008/06/14

Business: Making the correct assumptions
By : Yap Ming Hui

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IN wealth management, you could go to three different wealth management advisers and get three completely different financial plans depending on the assumptions used in the calculations.

It boils down to the assumptions used by the wealth management advisers.

Some of the key assumptions that will result in the wide variations are: - The expected rate of return (ROI) - Rate of inflation - Marginal tax rate of the person - How long will the person live - The income the person needs to support his lifestyle in retirement


I will now highlight how different assumptions used can affect the amount required for a retirement nest egg.


Wong is 45 years old and earns RM100,000 per annum. He would like to retire at 55 and estimates that he is going to need 60 per cent of his current income (RM60,000, taking into consideration inflation value).


He would like to use two per cent as the rate of inflation and eight per cent as the rate of return.


Based on the above factors, he would need RM991,076 for his retirement by the age of 55. With this amount in place, Wong can afford to spend RM60,000 per year and finish spending his capital at the age of 80.


However, by varying the assumptions used, we can get different results.



Rate of inflation


If Wong used four per cent as the rate of inflation, then the retirement nest egg required would be RM1,465,771 instead of RM991,076.


With a difference of two per cent in rate of inflation, we have a difference of RM474,695 in the amount required for the retirement fund.


The rate of inflation experienced by any individual or family is basically dependent on two main components.


First is the basic inflation factor experienced by the general population. This rate of inflation can be projected by using the rate of consumer price index.


However, each individual and family also experiences an inflation that we term as life style inflation. Life style inflation basically refers to the inflation on those items consumed other than the common household items, for example the car, house to stay in and holiday package.


Since the different inflation rate will influence the end result of any wealth management, it is important to use a rate of inflation which is as accurate as possible.


In an era of high inflation, we need to review the assumed rate of inflation. Without adjusting the rate of inflation, you may under prepare your various financial goals.


Income needed to support retirement living


If Wong decides that 80 per cent rather than 60 per cent of his current income would be sufficient for him to enjoy a comfortable life style then he would need a retirement fund of RM1,321,435 instead of RM991,076.


With a difference of 20 per cent in the income needed for your retirement, we have a RM330,359 difference in retirement fund.


Undeniably, the figure will become more accurate as you get closer to retirement. There is a rule of thumb that suggests a person will need about 60 to 80 per cent of his pre-retirement income. To have a more accurate projection, you must continue to update the calculation as you get closer to retirement age.


How long will you live


Wong chose 80 years as his life expectancy for his retirement plan calculation. If he chooses to use 95 years, the retirement nest egg will change to RM1,166,515 from RM991,076.


It is obvious that the assumptions made on your life expectancy have a relatively smaller impact compared to the other assumptions. If you live longer than you have assumed, then you risk outliving your money.


Rate of return


When we use an eight per cent rate of return, Wong would need RM991,076 by the age of 55. If he were to assume that he could achieve 12 per cent rate of return, he would need RM730,280. With a four per cent difference in the estimated rate of return, we have a difference of RM260,796 in the retirement fund needed.


While you may want a higher rate of return, no one can guarantee what the financial market will earn eventually.


So what rate of return should be used in your financial plan? It should be the rate linked to the economic outlook, your personal asset portfolio mix, the inflation rate and the long-term historical rate of return for your investment asset, less management charges.


In order to have a more accurate financial plan, we must be cautious in deciding various assumptions used in wealth management calculation. Since the impact of using the wrong assumptions could be a financial disaster, you may want to confirm your assumptions with an independent wealth management professional.


In fact, a prudent practice would be to do more than one financial projections in each scenario so that you can see the impact of the different outcomes on your ability to achieve your financial goals.


One financial projection is certainly not enough, not when preparing a business plan, and not when doing a personal financial plan.


Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia.

http://www.nst.com.my/Current_News/NST/Sunday/Focus/2265087/Article

Roadmap to financial freedom

Business/Your Money: Roadmap to financial freedom
By Yap Ming Hui

2009/03/08

IN my previous articles, I had discussed the five essential elements of financial freedom namely, spending, inflation, return on investment (ROI), time and saving. If you have knowledge of these elements it is good. However, knowing and understanding the five elements will not help you achieve financial freedom. Knowledge is only powerful when you apply it. Therefore, the challenge is to apply the knowledge of the five elements to your own real-life situation. Do you know how?

Let me share a real-life case study of Muthu. The following details of him:

- He is 36 years old and the wife is 34 years old

- He has two children age 8 and 5 now

- He works as senior manager in a multi-national corporation with RM120,000 annual income. His wife works as adminis-trative manager with RM100,000 annual income

- He has the following financial assets:

-- House: RM500,000 with RM250,000 mortgage loan

-- Unit Trust: RM30,000

-- Bank savings: RM200,000

-- EPF: RM200,000 (himself), RM150,000 (wife)

- He and his family is currently enjoying a life style of RM120,000 per year.

- He and his wife intend to retire at 55 with RM96,000 living expenses per year.

- They would like to provide RM200,000 each for their children's tertiary education.

Do you think Muthu will be able to achieve his financial freedom (assuming that he expects to live until the age of 80)?

Will he or will he not?

The best way to answer this question is to plot a roadmap to financial freedom for Muthu and it would look like chart A.

The Y axis of chart A represents the net worth amount of Muthu. The X axis represents the age of Muthu.

From the roadmap, we can see that Muthu's net worth will grow to about RM400,000 when he is 45. But it drops to almost zero at 46 when his first child goes into university. After that, it rises slightly but drops to zero again at 49 when the second child enters the university. His net worth stays there until 55 when he withdraws his EPF money. Then, his net worth grows to about RM1,100,000.

At age 57, his wife withdraws her EPF money and their family net worth grows to about RM2,450,000. From there, their net worth continues to drop. Their net worth becomes zero when Muthu is 65. In another words, Muthu's wealth will run out at age 65.

Based on Muthu's desire to have his wealth last until age 80, the roadmap shows that his current money management will not achieve all his financial needs and wants.

It is important to have a roadmap to measure our progress towards our goal of financial freedom.

By having the roadmap, we are able to know where we stand now in our journey to financial freedom, and the necessary actions to take to move towards that destination.

Without a roadmap to financial freedom, you won't know if you have enough financial resources to meet all your financial needs and wants. Without this knowledge, you may continue to over-spend and under-save. When you realise the problem at age 50 or 55, it is already too late to make any changes or take any actions.

In short, managing your personal finance without the roadmap to financial freedom is like shooting a target in the dark. You don't know where the target is and you don't know whether you have shot the target.

By knowing his current roadmap, Muthu will be able to take some actions and re-prioritise his financial needs and wants to achieve his financial freedom.

First, he can restructure his investment portfolio to achieve higher ROI. His current investment's ROI is 3.8 per cent. If he is able to achieve nine per cent ROI for his investment portfolio, his roadmap will look like chart B.

After increasing his ROI, Muthu's net worth will last longer now from age 65 to age 68. This is still not good enough. The target is to have the money last beyond age 80.

In that case, he will need reduce his life style spending during his retirement from RM96,000 to RM84,000. It means RM1,000 less per month. Muthu is willing to make the adjustment to make his wealth last longer. After the adjustment, his roadmap will look like chart C.

After reducing his retirement life style spending, Muthu's net worth will last until age 71. This is better but still not good enough.

Based on the adjusted roadmap, Muthu will need to adjust his current life style spending to increase his savings. If he reduces his current life style spending per year from RM120,000 to RM105,000, he will have additional RM15,000 savings per year. Then his roadmap will look like chart D.

After reducing his current life style spending Muthu's net worth will now last until age 83. By making those few adjustments Muthu is now able to achieve his financial freedom.


* Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, which has recently launched Roadmap to Financial Freedom service to help guide Malaysian families to achieve financial freedom.



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© Copyright 2009 The New Straits Times Press (M) Berhad. All rights reserved.

http://www.nst.com.my/Current_News/NST/Sunday/Focus/2498095/Article/pppull_index_html

Our financial needs and wants in life

YourMoney: Our financial needs and wants in life
By Yap Ming Hui

2009/02/22

IN order to achieve your financial freedom, you must know clearly what your financial needs and wants in life are. Your personal financial management should make a healthy contribution to the realisation of the life that will make you happy. Contrary to most financial planning practices, I will not define your financial needs and wants before defining what a good life is to you. If you expect your money to contribute to your good life and you're not clear about what that good life is, how can you possibly get there?

In order for your money to be more than just a financial figure, it is important that you identify and articulate your definition of good life.

It must not be the social norm version of good life. Your self-defined good is your innermost driving force. It gives you a sense of direction and purpose. It motivates you to your highest levels of energy.

Your financial needs and wants are about supporting a good life that is consistent with your core values and beliefs and it's the starting place for any money management. Your own definition of good life is there, within you. But most of us simply haven't identified it.

To share with you a guide on defining good life, I would like to quote a formula outlined by Richard J. Leider and David A. Shapiro in their bestselling book Repacking Your Bags.

"Living in the place you belong, with the people you love, doing the right work, on purpose."

According to them, good life is an integration -- a sense of harmony among the various components in one's life.

It means that, for example, the place you live provides adequate opportunities for you to do the kind of work you need to do. And that work gives you time to be with the people you really love. And that your deepest friendships contribute to the sense of community you feel in the place you live and work.

The glue that holds the good life together is your purpose. Defining your sense of purpose -- the reason you get up in the morning -- enables you to continually travel in the direction of your vision of the good life. It helps you focusing on where you want to go and discovering new roads to get there.

If you are interested in finding out more on how to define your own good life, I suggest you can read Repacking Your Bag or any other life-planning books.

Only after defining what good life is, can you move on to identify the financial needs and wants required to support your good life.

The following are some of the questions that you can ask yourself to identify your financial needs and wants in life:

- When would I want to retire and how much income will I need to maintain my desired retirement life style?

- How much tertiary education do I want to provide for each of my children? By when do I need the money?

- How much do I need to finance my annual vacations? How about my vacations during my retirement?

- How much would I need to maintain my current life style?

- How much would I need to buy my dream house?

- What are the other financial goals that I would like to achieve and how much will they cost me, and when would I need it?

A sample list of financial needs and wants

Below is one of my client's list of financial needs and wants for a good life.

- I would like to retire at 50 with RM96,000 annual income.

- I want my wife to retire earlier at 35.

- I would like to provide RM200,000 each for my children's tertiary education.

- I would like to set aside RM20,000 for my annual vacation and I hope to double it to RM40,000 when I retire.

- I would like to maintain my current family lifestyle of RM120,000 per year.

- I am happy with my current house. I will not need to buy another house.

When you develop your list of financial needs and wants, don't be restricted by your current financial resources. You should focus purely on defining the financial needs and wants that will give you the good life you want.

That's what we mean by defining the financial freedom goal that you really want in life. When you do that, you will develop a strong sense of belonging to the financial freedom goal that you set because it means a lot to you. When you do that, you will not blindly follow the common financial freedom goal of just wanting to become a millionaire or a multi-millionaire.

Each one of us will have our own financial freedom goal. Therefore, each will also have our own code for our financial freedom.

We need to find out what combination of spending, ROI, inflation, time and saving is the right code for us to achieve our own financial freedom.

Have you found out what is your code to your financial freedom? If you have, you are on the right track to achieving your financial freedom.

If you haven't, you better start finding it out now before it is too late, because without the essential element of time, it is going to be difficult, if not impossible, to achieve your financial freedom.



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Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, which has recently launched Roadmap to Financial Freedom service to help guide Malaysian families to achieve financial freedom

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© Copyright 2009 The New Straits Times Press (M) Berhad. All rights reserved.
http://www.nst.com.my/Current_News/NST/Sunday/Focus/2484254/Article/pppull_index_html