San Diego Housing Market News and Analysis

AN, you need to discount the cash flows to arrive at the comparable 401K value (use the NPV function on your table.)

A $100K income with 2.5% annual raises using a 4% discount rate over 30 years gives a present value of about $2.3 million.

Those 2.5% raises are worth about $600K

People with 401Ks don't get the raises.

Should we include medical benefits? Let's throw in another $10K+ per year...

So what you're showing there is if the annual pension payments are invested every year for 30 years it will be worth that much? That's not the same as retiring with a $3 million 401K.

For it to be equivilent to a $3 million 401K, you have to start with $3 million and reduce it every year by the $100K and add investment income. I don't have to do the calculation. I know that 7.5% annual investment return will yield $225K a year without ever reducing principle.

But I did the calc. $1,250,000 with annual withdrawals of $100K on the first day of the year, 7.5% earnings will last for more than 40 years.

Can you explain why we need to take NPV into consideration?

My calculation is just the total amount of money someone with $100k pension would get over 30 years assuming 2.5% anual raises.

If there's no raise, $100k/year for 30 years = $3M. But because of the 2.5%, it comes out to be about $4.39M.

Everyone invest, spend, save differently in retirement. Which is why I'm trying to make it simple and not count in the appreciation during retirement and I assume total depletion at 30 years.

So, if I count in NPV, which if I assume 4% discount rate like you suggested, then you're right, it'll be more like $2.4M. But if you take inflation into consideration for this calculation, then you'd have to take inflation into consideration for the 401k case as well. Assuming you have no growth in your 401k over 30 years.

I see you're adding in the anual investment return for the 401k side. I didn't do that. If you add in investment return, then you're adding risk. BTW, where can I invest that guarantee 7.5% for 30 years? I S&P didn't do that between 1950-1980. It's definitely below its 2000 value. Will we cross the 2000 value in nominal term any time soon? I have no idea. This is why I assume 0% investment return. There are so many variables. If you retired in 2000 and you put your money in index S&P, you lost money in nominal term over the last 12 years. I haven't even counted inflation or the expected 7.5% return.

a 7.5% guareenteed return is insanity. Right now you cant get close to that right now. Even if you get it later you will draw down even more principal now making the return requirements even higher later. A conservatively managed retirement portfolio would struggle to return 4% over the last 5 years.

Yeah, CalPERS used 7.5% also.

How'd that work out?

A defined benefit plan always has an implied long-term rate of investment return.

Unless of course, they are getting their returns from something other than the invested capital. Which is exactly what many public pension plans are doing right now.

The assertion (I believe) was that a $100K pension was the equivilent to a $3Million 401K. It simply isn't. Nothing about annual raises. Nothing about inflation. With a 401K you have unlimited flexibility. Skip withdrawals entirely until you're 70. Even after that, minimum distributions are pretty small. 100% of any remaining balance can be left to an heir, with a pension you can't do that. (Possibly a lower survivor annuity.)

The only way to compare is doing a NPV analysis. That, of course, ignores the possibility of a premature death, in which case the value goes way down. So even using a 40 year life is probably overstating the requirement. 30 is probably more reasonable for retiring at 55.

S&P compound annual growth rate of more than 7.5% going backwards from 2011, for any period more than 16 years.

Using 4%, you could get annual payments of $100K a year for 38 years with $2.4 million, assuming the first payment was at the beginning of the first year. (Monthly payments would probably come close to extending that life to 40 years.)

So at 55 years old, if someone is going to offer you either a $100K a year or $3 million in a 401K, which one are you going to take?

Jan 4, 1993 - Jan 5, 2009

4.9%

http://finance.yahoo.com/echarts?s=^GSPC+Interactive#symbol=^gspc;range=19930104,20090102;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefined;

Didn't take long to find that one. I'm sure there are a few other examples.

We all understand the model. We all understand the historical averages and trends.

We also should understand (we are Piggs, after all) that there are no long-term absolutes.

sdr pointed out that all it takes is a few exceptions and the whole thing breaks down.

Defined benefit plans rely on long-term absolutes. If they depended solely upon market returns then they might actually be feasible. But they depend on much more. They depend on managers and bureaucrats not making a single mistake for decades. That's never going to happen.

Have you heard of the Black Swan? The book sucks, but the concept is undeniably true.

You didnt actually find anything that refutes what I said. I said going backwards from 2011.

But obviously there are no absolutes. Which is why i reduced it to a 4% return.

Over the last 10 years 4% is too high. I have personally managed a portfolio in the ranges of values we have been talking about for a retiree over the last 10 years and know what the returns have been. We werent invested in stocks until the last year or so. We've done well by investing in high quality/high yield dividend stocks that came into favor several months after we got into them. Otherwise returns were minimal at best in asset classes appropriate for a retiree.

It wasnt until we realized the benefiary couldnt possibly outlive their assets and started taking on risks more appropriate for the eventual heirs did we get above and beyond 4%.

I would be more concerned with this guy looking into your windows.

You don't need to know anything about investments and still could easily achieve/exceed an average of 4% returns for the last ten years using nothing more than following the ben stein's couch potato portfolio.

Total Intl Stock: 6.8%
Total Bond: 5.45%
Total Stock: 4.9%

So if anything, a 4% annualized returns for the last 10 years is too low.

Obviously you have never managed a retirees portfolio. None of those are appropriate for someone whose first priority is safety of principal and number 2 is income. There is no number 3 for a retiree.

I guess I don't understand what you mean about a 16 year period, but that really has nothing to do with the crux of the issue anyway.

The issue is: Who bears the risk?

And every single person on this site that has ever defended public-sector pensions simply avoids that question completely.

Details about market returns and back pain are just a distraction.

It's about bailouts, plain and simple. Let's call it what it is. Privatized gains, socialized losses. Yup, it doesn't just apply to bankers.

There is no reason the government should be managing and guaranteeing investment portfolios for the benefit of a minority of the population.

I won't avoid the question. It's an easy one. The employer contracted for the liability, so assumes the risk. Exactly as with defined benefits in private industry.

I get it. You think that's wrong. But it's been that way for scores of years. And worked quite well for scores of years, particularly in years with outstanding investment returns requiring little, or in some cases, no contributions. I don't remember a lot of complaints then that retirees were stealing money from the taxpayers.

I said it is worth $3,000,000.

I suggest you use the internet and get some online free quotes for annuity that will pay $100K a year starting at age 55. That's straight annuity with joint survivor benefit. Typical cost today is $2.2 Million. That doesn't include the COLA benefit the retirees get. That adds another $700-900K. You can estimate it yourself by looking at what it would cost to add the $16,000 COLA growth after the first 5 years, that would be a $16000 a year annuity starting at age 60, hint (about $250K). Then another $20K one at 65 (hint $300K+). Then another at 70.

OR run a retirement simulator that shows to have a 90% survivability you need less than a 4% withdrawal rate.

The reason is simple, volatility. If you thought you weathered the storm at Y2K and retired on less, 2002 would basically leave you destitute today.

Weathered 9/11 and the 2007 meltdown would have you worried if you started with less.

But quibble if you want, maybe it's $2.5 MILLION.

Long term averages don't matter that much either, it's the big drops you worry about. You have to have a big enough pile to survive and continue to withdraw and be able to rebuild while withdrawing after a big drop, like in 1987, 2001, 2007.

I wanted to say something to this earlier and I know its a bit late but simply... I don't support most of these activities by the goverment... Nor do I want it...

CE

No, I have never managed a retirees portfolio. It would be a disservice to those folks if I claim I know more about investments than what I really know. I also know enough to understand that just because you're retired doesn't mean you need to "retire" your investment style. If you believe in the market during your working years then why should that changed when you retired? You might want to play a little defensively and make sure you have a "bucket" of money invested in something that is shock-proof to the market downturn, but continue to invest the rest of the money in the equity market. If a retiree goal is to protect the principle then why pay for someone to do it when they could do it themselves by either stick it under their mattresses or a saving/cd account if they're less risk adverse.

MASTER! Take me as your student! :P

CE

I am not paid for managing this portfolio but the responsibility that comes with it is enormous. There are major differences between investing during your working years and when you are retired but here are the big 3. When you are retired there are no more contributions to your retirement fund-you have to deal with what you got. When you are retired you do not have time to recover from bad losses. When you are retired you dont earn an income anymore so you either generate income from your assets or you spend down your assets. Nothing is scarier to a retire than spending down their assets.

It's mostly just semantic, but I'm going to take exception to this. I understand the concept, but you can't spend income. You can only spend assets. And unless assets are primarily invested in non-liquid investments like gold, raw land, or real estate, actual cash flow in the form of dividends or interest is incidental. Marketable securities can easily be converted to cash. So growth is as important as cash flow, since either can provide cash for withdrawal. Either way, a retiree is always spending down their assets. That's the only thing they can spend.

I said you dont "earn" income not that you dont spend it. Spending "DOWN" assets implies your account value going down not that you arent spending your assets. There is nothing more frightening to a retiree than watching that account value go down. That creates concern of being a potential burden on their children who are working to raise their own families. Its a completely different mindset. Sit down with a 70 year old, 75 year old or 80 year old once a month for 10 years to talk about these things and your outlook will change. God willing someday you will be in that position too and will understand.

I agree. It sucks to have to work all your life and still not able to have a worry-free retirement. If your goal is to preserve the principle and investing like one then you're going to run into the risk of running out of money before you die. Here's one tidbit about the market, I don't think it ever had a negative return over any 10-year period.

The only time you can truly have a worry-free retirement is when your money can make more money from extremely safe investment (CD) than you can spend. Then you can a more worry-free retirement. I'm definitely not risk adverse by any stretch of the imagination, at least not right now. This is because I know I have time on my side and I can ride through any down turn and I'm still making money so I can dollar cost average if I need to. However, I know that when I retire, I will be extremely risk adverse. Which mean I won't want to retire until I can truly live off the earning of my money when it's mostly in CD and bonds. I'm sure most retiree would fee the same way.

With your tidbit, which market are you referring to? The DOW is lower in 2009 than 1999, it's lower in 2010 than 2000, it's lower in 1975 than 1965, it's lower in 1982 than 1972, it's basically flat between 1962-1982 with some swing between 600-1000. The S&P was lower in 2010 than 2000, lower in 2009 than 1999 & lower in 1975 than 1965. Again, these 10 years period might not matter as much to those who are working. But to those who are retired, 10 years with 0 or negative growth means they have to deplete their nest egg. Depleting nest egg means they'll have less $ to participate in the market when they come back up. Which mean they would have to earn a much higher % of return to make up for the amount of money they lose when the market crash.

You're definitely much more righteous than I am then.

You're assuming those in the public sector have no saving and their only source of money saved for retirement is the pension. These flexibility also apply to the money public employee save. If anything, they have much more flexibility. Since they can just spend their pension money for retirement and the money they've been saving since they start working can grow until that die without ever being touch. That would be a huge chunk of money if they let it grow for 60+ years. We all know time is compound interest best friend. Especially when it money is allow to grow without being withdrawn.

NPV is not the only way to compare. But lets take the NPV number. $100k pension growing at 2.5%, the NPV would be ~$2.4M. That's still a huge chunk of money. Assuming you're in the private sector, to amass $2.4M by the time you're 55 and you start working at 22. You'd have to save on average of $72k/year for 33 years if you have no growth. But, I'm sure you'll say, but you have to take growth into consideration. So, I use 8% growth, which is definitely on the high side. You'd still have to save $15k/year, every year for 33 years to amass $2.4M nest egg. How many 22-30 year old do you know that save $15k/year every year since they get out of college at 22?

Past performance is no guarantee of future return. At this snap shot in time, I definitely don't expect the S&P to grow at 7.5%. If it does, the S&P will be at ~4200 in 16 years. It's currently at ~1300 today. I wish it would but I'm not holding my breath. The S&P was at ~1400 in 2000. We're 12 years past that point and we're below that peak. If you expect average 7.5% return from S&P every 16 years, the S&P need to be at ~4400 for you to meet that 7.5% average goal. I don't have a crystal ball, but I don't see the S&P getting anywhere near 4400 in 4 years. Do you?

Again, even at 4% is no walk in the park, depending on when you retire. The last 12 years is no walk in the park. To get 4% average annual return from 2000, S&P needs to be at ~2600 in 4 years. I don't see S&P doubling in 4 years. So, if you have that $2.4M in 2000, over the last 12 years, assuming you have to stomach to keep 100% of your net egg in the S&P, you're only only negative nominally, you're depleting your nest egg at $100k a year, which is $1.2M over that 12 years. So, 1/2 of your nets egg is gone and you're only 12 years into your retirement. Do you think the remaining $1.2M can last you the next 18 years?

I'd take $100k a year in a heart beat. But these pension are not just $100k/year, it's $100k/year + yearly increases of 2.5%-3.5%. I'd take that in a heart beat.

All of these calculation is assuming you'd die after 30 years. The pension looks even more lucrative if life expectancy get to 40 years. With the advancement of medicine in the last 30 years, I expect that in 30 years from now, 100 years old will be the new 70.

That's what I used to think. But I am really sold on idea of splitting your retirement $$ into various buckets so on the one hand you'll know you will have steady flow of income for x number of years regardless of how the market performs; and on the other hand you'll know that your retirement $$ will have the opportunity to grow.

I was referring to the S&P & DOW. The DOW might be lower in 2009 and 2010 compared to 1999 and 2000, respectively. However, the returns during the 10-year periods were still positive. You're right about the possibility of depleting your nest egg. That's why I don't think you want to switch to investments that could barely keep up with inflation during your retirement years.

I understand what you're talking. I assume you're referring to the bucket of money strategy from someone like Ray Lucia?

That would be my 2nd option. My 1st option, if I achieve my net egg goal, is to accumulate enough where I can ladder CDs and make more than enough on dividend to live on. If I fail to reach my 1st option, then bucket of money strategy would by my 2nd option. But that just mean I failed and am just trying to make due.

Return between 1999-2009 and 2000-2010 were not positive. They were negative. Like I explained in an early post, depletion of the nest egg drastically affect your average return. So, if you have $2.4M in 2000, over the last 12 years, assuming you have the stomach to keep 100% of your net egg in the S&P, you're not only negative nominally, you're depleting your nest egg at $100k a year, which is $1.2M over that 12 years. So, 1/2 of your nets egg is gone and you're only 12 years into your retirement. Do you think the remaining $1.2M can last you the next 18 years? What if Europe or China goes into the toilet in the next year or two and we'll see another crash. What would happen to that remaining $1.2M? This is why I wouldn't want to be in the market if I'm retired.

I'm not assuming anything other than the facts presented. Pension v. 401K. Both private and public retirees could have other assets or no other assets. There's really no question that the 401K provides greater flexibility. The pensioner can't decide to skip distributions for a year, or reduce distributions in order to reduce taxes.

Most of this doesn't matter. I was only comparing pension v. 401K at retirement age. How it happened is incidental. I'm not sure what the 2.5% growth is you're referring to. SD cops pension COLA's are capped at 2%. And their average pensions are under $65K

As I said, the COLA's aren't 2.5-3.5%, they're capped at 2%. And the assumption was not death after 30 years, at 4% it lasts over 38 years. And you overestimate life expectancies. 80 may be the new 70, but 100 certainly won't be.

If you win the lotto, are you going to take the annual payout or the lump sum?

You're assuming that as a retiree you'll stick your entire nest egg into a single S&P or the DOW "bucket". But that's not how the that thing works. And the assumption that you'll withdraw the constant amount every year is also flawed. These buckets are rolling buckets - you'll need to rebalance every year. On lean years you'll need to withdraw less. So sure you'll run into some rough times here and there, but the whole idea is that that doesn't matter if you have money invested for now (ultra defensive, principle preserving) for the near-term and the long-term(go for broke, swing for the fences). In other words if you plan to live for another X years after you retired, then put 1/3 of your nest egg under your mattress (and replenish at the end of each year). Another 1/3 in some other not so risky investment And for the last 1/3, invest as you are investing today. This is just a general example, but you get the idea of splitting your nest egg into various buckets.

BTW., I haven't read up Ray Lucia's books, but BStein did mention RL in his book. I like BStein's method in that he took various strategies (RL buckets of $$, Galeno's, etc..) and refined them by running those through various scenarios and making adjustments. As a bonus, his self-deprecating sense of humor makes his books both educational and entertaining.