Friday, June 04, 2010

A Home Work Assignment for Any Cappy Cap Reader That Wants It

Driving around the Lake Minnetonka area today because, well, what else do you do on a 78 degree day when there is no work to do and while listening to the news I slowly saw the Dow drop 100, 200 and then 300 points and then had an interesting thought.

"Based on the number of retirees, pensioners, present and future, and considering the amount of money being invested in the stock market, and based on average life expectancies and cost of living requirements, how much will the stock market have to go up by in order for traditional retirement plans to succeed?"

In all of my studies and research there was always that 8-9% annualized price appreciation in the stock market that was assumed to go on into perpetuity. With the collapse in long term economic growth, what if the entirety of Americans relying upon their 401k's and IRA's, just plain don't get 8-9%? What if it's going to be something more like 5-6%, or maybe like Japan, 0 to -2% for the next 20 years?

Regardless, I am curious what the "Dow would have to be" in order for everybody's retirement plan to work out the way it's supposed to. If somebody wants to take a crack at it (on account that I am lazy) I would certainly be interested in seeing the numbers as well as the methodology.

And then I will laugh heartily when we see how egregiously and impossibly high that number is compared to the reality of American economic productive capacity.


Anonymous said...

A different homework assignment.

First, look up the poverty level annual income for your area and household size. We'll refer to this number as P.

1. Suppose you lose your primary source of income. Add the total amount you have in savings, other reserve funds, assets you'd be willing to liquidate, and the amount you are currently earning per year from secondary sources. Divide by P.

2. Estimate the total amount of money you saved in household expenses by doing things yourself. Divide by P.

3. Suppose you lost your job and that there were no openings using the same skill set in the same industry. Find out the highest reasonable starting annual pay for something you would be qualified and willing to do. Divide by P.

What would happen to the economy if people could be pressured to maximize these scores?

What would happen to the economy if children could be indoctrinated into reserving the highest esteem for those with the highest scores?

Anonymous said...

I'm not going to do either homework assignment. Sorry. Joe said there'd be no math.

While 8-9% on average would be nice, my plans do not rely on it. My plans are fine with a 2.5% average return and OK with a flat market for a while.

The things I do fear are:

a) a layoff within the next 5 years - the issue here is I can't continue to contribute to my 401K and investments and I lose medical coverage. I expect getting another comparible job to be darned near impossible due to my age and the business that I'm in. Unfortunately, the odss of survival more than 5 years are extremely low due to cost- cutting and offshoring.

b) rising interest rates - when I retire my monthly pension benefits are impacted by interest rates - the high the rates, the lower my monthly benefit. On the other hand, I could move my 401K and investments to reap the benefit of those rates.

c) rapid growth and expansion of taxes - two words Obama Administration - enough said.

d) inability to get good medical care due to the takeover of heathcare by the Federal government.

e) government takeover (stealing) of my 401K.

f) loss of social security - losing social security based on the current numbers, retiring at 66, would cost me $40K in annual income.

g) a world-wide depression - I'm not sure Europe is getting the message that their economies can't handle the burdens of their welfare states - I know Obama doesn't get it.

EarlW said...

Back to what it was in 2000. 10,000
I can dream, can't I?

Hot Sam said...

It's an easy question but you have to give us more information.

How old is the person now?

What is the current dollar value of his financial assets?

What is his expected annual consumption expenditure in current dollars?

The previous value of his retirement portfolio is irrelevant because it was unrealized value. All that matters is the current value of that portfolio.

Current age: 50
Current consumption: $40,000
Retirement age: 67
Annual inflation: 3%
Expected return on investment: 5%
Life expectancy: 85

Future consumption would be $66,114 per year at 3% inflation.

To support that consumption, he would need $745,374 saved by the time he retires.

If he has nothing saved now, he would need to save $2400 per month to meet that goal. If he has $50,000 saved, he would need to save $2034 per month. If he has $100,000 saved he would need to save $1665 per month.

If the person with no current savings put those payments into an index fund with no net dividends or taxes, the DJIA would have to be at 22,500 for a 5% required rate of return.

If social security exists, he'll receive about $3000 per month. This would reduce his retirement needs to $350,700.

This person with no savings would have to set aside $1131 per month. If he had $50,000 save, he would have to save $761 per month. A person with $100,000 saved would need to save only $392 per month.

Of course, the answers change quite a bit if you increase the average rate of inflation or lower the average rate of return.

Anonymous said...

Laffer's got it