Pension Funds and Assumed Rates of Return make an A** out of You and Me
Last week I had an interesting conversation with my client regarding our fears about pension funds and assumed rates of return. I mentioned that two of my biggest fears are this year’s seven-year bull market and the market’s correction. My client agreed with me, but I was left confused and intrigued. I wanted to know more. What are pension funds and assumed rates of return? Most pension funds assume a rate of return to get the target value into their funds. For example, If you have an assumed rate of return of 10%, you’ll need a certain number amount to pay for all employee pensions. You’ll double the amount, however, if you assume a 5% rate of return. Most pension funds currently have 7-8% assumed rates of return. I eagerly injected as my client is explaining the assumed rate of return. “Shouldn’t there be a 5% assumed rate of return because of the low growth mode?” My client laughed. He answered that the pension companies would never change because the very structure of the system would be dismantled. Who would have thought that the assumed rates of return were such a realistic fear? This is scary. What The Experts Are Saying Global chief economist for Vanguard Group, Joe Davis adds, “Global growth has been frustratingly fragile. In the last three years, it has been significantly lower than the cycle a decade ago, and there is little acceleration in any economy of the world right now.” Therefore, assumed rates of return should be closer to 6% or lower. As a result, the state would have to come up with the money to fund the deficit created within the pensions promised to employees. For example, Hawaii just lowered the assumed rate of return from 7.75% to 7.50%. The 60% funded ratio was ranked the ninth worst in the country (2013 statistics). Only two states, South Dakota and Wisconsin were 100% fully funded. Illinois (39%) and Kentucky (44%) were the worst. For more information visit this link. You can learn even more here. The Inverse Relationship Between Rate of Return and Your Pension Fund It is imperative to understand the inverse relationship between the rate of return and pension fund money. If you lower the rate of return, you will consequently need more money pushed into the pension fund because the capital demand must be met in the future. This is based on the assumed rate of return. So where will states get these funds? The public sector, the taxpayer. What can be done in the public sector to help this situation? What if Marijuana Was Legalized? Did you know that the tax rates for marijuana are 25-40%? Think about it in terms of generating funds from taxpayers. I would argue that the state pension fund shortage could be offset by the legalization of marijuana. Visit this link for more information. Medical Marijuana Is A Valuable Asset in Legalized States I never knew how much money there was in medical marijuana until I had a phone call with a Medical Marijuana Dispensary owner. I was blown away. If you haven’t seen it, please check out the CNBC program that highlights the medical marijuana dispensaries and their business model. Learn more here about the effects of marijuana on tax income growth. Marijuana tax rates generated by its legalization can effectively mitigate this frightening circumstance, especially after contemplating the fears of the assumed rate of return. Legalizing marijuana would allow its consumers to pick up the tax burden, which would enable states to conservatively decrease their assumed rates of return. Makes sense.
Baby Boomers Forced to take Required Minimum Distribution
Baby Boomers are a very large portion of our population. They’ll be taking their first RMDs this year. RMD stands for Required Minimum Distribution. The Government forces us to pay taxes on our retirement account when we turn 70 years of age. This is only on qualified plans (IRAs, 401Ks, and other qualified accounts). Consequently, only the people who have needed the income have had to take money from the market. That’s only up until this year. Edward Shane from BNY Mellon adds his own sentiment. “As a result, throughout the next 20 years, billions of dollars annually will be forced from retirement accounts through distributions. These distributions will, in many cases, be taken in the form of a single large annual payment.” The Required Minimum Distribution & The Bull Market Our whole population will be forced to pull out their first RMD for the first time this year. The RMD percentage goes up every year to force people to draw down their account value. As a result, the government gets tax revenue. Kristen Grind from WSJ said, “Assets held by 401(k) plans ballooned to $4.6 trillion in the fourth quarter of 2014, up 171% from $1.7 trillion in 2000, according to the Investment Company Institute, a trade organization for mutual funds.” Currently, We are sitting in a 7-year bull market. A bull market means it keeps going up and up. I think if you pair the expectation of an increasing market with a forced RMD, probably any drop in the market would be crushing to Baby Boomers. Consequently, this is good for the government and taxes, yes. What about the market and the young people investing in it? Assuming the average size of a retirement account is 250,000, here are the numbers: In this case, the resulting withdrawal of $9,124.09 represents 3.65% of the retiree’s retirement balances at the time of the calculation. Note that, over time, the formula results in a growing distribution percentage. However, it is eventually applied against a declining balance as withdrawals (likely) begin to exceed earnings in the account. Source: IRS5 Edward adds “The impact of these events will be substantial and will pose a challenge to the retirement industry. After decades of asset accumulation, this unbridled exit of funds is poised to have a material and adverse impact on the retirement companies that manage these accounts. “ Converging Elements While the actual valuation of current RMD outflows and projections of future distributions are inexact in the absence of hard data, consider the following statistics: The value of retirement assets for all RMD-eligible plans currently totals an estimated $16.2 trillion. The current population of 50-69-year-olds who will reach RMD status over the next 20 years will increase by more than 27 million individuals. As a result, by 2035, the total number of retirees taking RMDs could swell to 58.7 million individuals according to census projections. It is estimated that more than 65% of current traditional IRA investors (and their assets) will enter into the RMD strata in the coming 20-year period.6 As a result, if projections are correct, up to $10 trillion in assets will be subject to mandatory withdrawals over the next two decades. A first-year withdrawal, based on the current IRS formula, requires a distribution of 3.65% of eligible assets. Furthermore, the percentage grows as the retiree ages and jumps to 5.35% for that same individual at age 80. As a result, at age 90, the mandated withdrawal percentage leaps to 8.77% of the account holder’s balance. http://www.cbsnews.com/news/will-retiring-baby-boomers-lead-to-a-stock-market-bust/ http://awealthofcommonsense.com/2015/06/will-retiring-baby-boomers-ruin-future-market-returns/ http://www.wsj.com/articles/net-outflows-befall-401-k-plans-1434408836 http://time.com/money/3922594/401k-millennials-baby-boomers/ Can the Gen Xers, Gen Ys, and Millennials replace those lost funds in the market with their contributions to their retirement accounts? I don’t believe they can. In conclusion, our younger generations are not savers, rather, they’re spenders. Look at how much housing has gone up and how much they are spending on student loans. That does not leave them enough. Just my thoughts – what are yours?
Rich Dad, Poor Dad: The First Book I Read That Got My Mind Tweaked…
Sometimes a book can really change your outlook and your perception of your opportunities. In 2002, I was working at Home Depot, assisting a friend in starting a painting company. Additionally, I was going to college full-time. I had some extra time on my hands lol. I had also just bought my first rental property. During this time, I went to a multi-level marketing event. They were selling a website portal where you could purchase groceries online. This was well before the time of Amazon. The business model was to have each subscriber pay a monthly or yearly fee, like Costco or Sams Club. Consequently, the subscriber would have the ability to purchase items online for delivery like paper towels, soap, and other household items. One of the guys at the event gave me two books: Rich Dad, Poor Dad by Robert Kiyosaki and Cash Flow Quadrant by Robert Kiyosaki. Are you looking for a book that will help you take the LEAP? These are probably my top two books that tweaked my mind! Start your business today! Cash Flow Quadrant: If You’ve Never Read It, You Must The “quadrant” is broken up into 4 parts: E (employee), S (subcontractor), B (business owner), and I (investor). The premise behind the whole book is that if you’re an employee, you trade your time for money. A Subcontractor (meaning a trade job – Lawyer, Doctor, Painter, Carpenter, etc.) you’re trading your time for money, but there is no real way to scale this. For example, if you are a doctor and you don’t show up, you make no money, because you have no billable hours. At the time I was painting houses so it really resonated with me to say, “Hugo, the only way that you can make money, is if you show up and paint this guy’s living room”. That, I understood. It changed the way I started to think. If you are a business owner you are still working in the business and on the business and have to be there to manage that process. But you can scale, grow and make more money. As an investor, you are looking for passive income opportunities. Such as real estate, where you can make the purchase once, and the amount of money you make is disproportional to your time spent. For example, if it takes you an hour a month to manage the property, and you are making $200-300 per month in passive income, your income is disproportionate to the amount of time spent on that property. If you purchase stock in a company and get a dividend and do no work, you are making more income with less effort. Both of these can be scaled. Rich Dad, Poor Dad: New Ideas That Inspire Entrepreneurs The second book, Rich Dad, Poor Dad, is about the author as a boy. He watched two dads (a friend of the family and a biological dad) work their whole lives. His own father was a schoolteacher and worked every day. His friend’s father was an investor. He saw how much wealthier this friend’s dad got. As a result, he started to work less and less. I have always remembered this. How can you think bigger? Think outside the box and look for new opportunities. For instance, with a SaaS (software as a service business) you probably spend a ton of money and a ton of time marketing it, growing it, and getting businesses to sign up for a monthly service fee. Furthermore, once you build it and build the client base, you are charging everyone throughout the month for the service. As a result, if you need to have Monday off, you can take Monday off and the world still turns and you still get paid. It is a great business model. But it does take a lot of work and time to get it to that point. (As a side note if you are interested in building your own SaaS platform, I am happy to advise you, to click here) Right now, I am back to being an employee, a business owner, and an investor. I get most of my income from the “E” quadrant but my goal is to start and grow more businesses so that more of my income comes from the “B” quadrant so that I can invest more money and time in the “I” quadrant. You can fit yourself into many different groups. I see the goal as getting to a place where you have enough passive income to be solely in the “Investor” category. Both of those books helped me see that there was more to life than just a job for 35 years. These books helped me take risks and explore new opportunities.
What Is A REIT & Will They Pop This Year?
In August, REITs real estate will be the 11th sector to be included in the S&P 500 What is a REIT according to Wikipedia? “A real estate investment trust is a company that owns, and in most cases operates, income-producing real estate. REITs own many types of commercial real estate. Ranging from office and apartment buildings to warehouses, hospitals, shopping centers, hotels, and even timberlands. Furthermore, some REITs also engage in financing real estate.” REIT Stocks: Higher Dividends I met with a client this past week. He brought to my attention that he was looking at REIT stocks. I asked him why and dug a little more. I’m a dork about learning new information. REITs pay out higher dividends and by law have to pay out 90% of their earnings. Wikipedia explains this here. “REITs are strong income vehicles because to legally avoid paying U.S. Federal income tax, REITs generally must pay out at least 90 percent of their taxable income in the form of dividends to shareholders” In conclusion, my client was only looking at this from the standpoint that if he owned index funds and mutual funds for that matter, those funds would have to now buy/hold. I was looking at it from a point of view that now all the “Index funds” are forced to buy into the REITs. That said, the theory is that there are REITs that will become the 11th sector in the S&P 500. Let’s go back to simple economics; supply and demand. There are a limited number of shares so if demand is forced to increase, then they will drive the price of all 25 stocks up. Time will tell.