Maybe next year…

For many months analysts have been saying a recession is on the horizon. They’ve detailed the reasons why and I’ve reiterated certain points at various times. Recession should occur within such and such months because it always has when indicators X, Y, and Z have looked like this, and so forth. I can’t tell you how many comparison charts I’ve seen in the past couple of years that offer a compelling case for a near-term recession. It’s out there somewhere, no doubt about it. But, as explorers of old quickly figured out, the horizon line never gets any closer.

Even though our economy continues to sail along nicely, dour predictions continue. Current expectations are for a broad-based slowdown sometime during the second half of next year. Whenever a recession occurs, and one will occur eventually because our economy is cyclical, what’s more interesting right now are the variety of explanations for why our economy has been so resilient.

One of the charts I shared last week offered a reason: wealthier households flush with cash are still happily spending. This surprised analysts because the consumer is supposed to be so unhealthy right now. Government subsidies ending and student loan payments resuming were supposed to cause consumption problems, and they have. However, the thinking is that a host of other factors, from homeowners having locked in low mortgage rates as incomes and home equity rose, along with remnants of Covid-era stimulus payments, continue to free up spending cash for many (but not all) households.

Here's a look at that chart from JPMorgan again.

Then this week it’s another article from the Wall Street Journal about how Americans can’t stop spending and offers reasons why with profiles of real people. This is fascinating because it dovetails perfectly with the chart from last week.

I think the bottom line is that economists and analysts are leaning on this sort of data in real time because, as with so much else post-pandemic, past isn’t always prologue. Eventually consumers will spend less and that will impact the economy. Until then we seem to be in good shape. But how long that lasts is truly anybody’s guess.

I’m only including snippets below but a link to the article will be at the end. As before, let me know if you’d like the whole thing and I can send it to you from my account if you run into the WSJ’s paywall.

Snippets from the WSJ…

Americans’ prolonged spending spree has confounded economists and resulted in a surging U.S. economy. What’s keeping their feet off the brakes?

A strong labor market, resilient savings stockpiles and rising values of their homes have consumers feeling good and willing to spend. Despite complaints about high prices, they are taking their children to concertspacking movie theaters, booking luxury vacations, buying cars and covering the costs of rent and dinners out.

Strong spending caused economists to be wrong about a 2023 recession, though they still predict cutbacks ahead.

There are signs that Americans’ elevated spending habits aren’t sustainable. Some 60% of Americans said they have fallen behind on emergency savings this year, according to a Bankrate survey. In September, they saved 3.4% of their income, about half the rate they saved in the fall of 2019, the Commerce Department said. And long-term interest rates—which make it more expensive to buy homes and cars and to borrow money—may only now be reaching the point where they will slow Americans’ roll.

Nevertheless, many of the factors that have driven the 2023 spending binge remain intact.

Americans are feeling rightfully confident about their job prospects and paychecks. 

“The strength of the labor market and the strength of household balance sheets has helped Americans weather some of that storm” of inflation, said Daniel Zhao, an economist at the jobs website Glassdoor. 

The cost of financing a home has marched higher since 2021, putting the average 30-year fixed mortgage near 8% and keeping many would-be buyers on the sidelines. Plenty of Americans who locked in low mortgage rates, though, have extra cash. 

Roughly 90% of mortgaged homes have a rate below 6%, according to calculations from Mark Fleming, chief economist at First American Financial Corp. About two-thirds of American households own their home, according to the Census Bureau. 

The pandemic gave Americans the opportunity to stockpile savings, and many are still benefiting from that cushion.

Overall, Americans accumulated more than $2 trillion in savings above the prepandemic trend by August 2021, according to estimates from the Federal Reserve Bank of San Francisco. Recent estimates of the remaining excess pandemic savings range from $190 billion from the San Francisco Fed to between $400 billion and $1.3 trillion from economists at RSM.

Pandemic-era savings also went to paying down debt, said Jonathan Parker, a professor of finance at MIT Sloan. That gives consumers room to borrow, even if they have burned through some of the extra savings, he said, adding that, “People have a fair bit of debt capacity before they start hitting constraints.”

Prices for many items are rising more slowly than they were a year ago. But consumers remain fixated on how much lower they were before the pandemic, a mindset that may be driving some people to buy a car or fix their home while they can still afford it.   

The experience economy continues to boom, with Delta Air Lines reporting a record 30% jump in earnings in the quarter ended in September and Ticketmaster selling more than 295 million event tickets in the first six months of 2023, up nearly 18% year over year. 

Again, here’s the link to the article that includes profiles and some interesting charts.

https://www.wsj.com/economy/consumers/5-things-us-economy-8a588781?mod=hp_trending_now_article_pos3

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Avoiding Common Medicare Enrollment Pitfalls

Medicare isn’t something I hear much about as a financial planner until there are problems. It might be having to change doctors because they’re no longer taking your insurance, or you’re forced to navigate within an HMO. Or maybe it’s medical bills that are much larger than expected due to out-of-network procedures and even denied coverage. While the former is at best a nuisance, the latter can substantially impact your bottom line.

While I’m not a Medicare expert, I’ve learned in my years working with clients that there are common threads to the various problems people report having. These often start with following inadequate or inaccurate sales pitches masquerading as advice. This is an unfortunate but understandable reality since Medicare, and our healthcare system more broadly, is so incredibly complicated. You have to trust somebody, right? Yes, but ideally you should also verify. And when in doubt, which should be most of the time when it comes to this stuff, it’s best to lean on official information and then pick up the phone to verify your understanding.

Open enrollment started this past weekend so it’s a good time to review these issues if you’re new to Medicare or are considering switching plans.

The following article from the WSJ looks at common enrollment pitfalls. I’ve left some of the hyperlinks to sources of helpful information and have italicized a few sections for emphasis while trimming the article down a bit. There’s a link to the full article below. Let me know if you bump into the WSJ’s paywall and I can send it to you from my account.

From the WSJ…

Seniors choosing Medicare coverage often fall into hidden, costly traps that can leave them stranded—and unable to get the healthcare they want. But there are ways to avoid the pitfalls, if you know how.

Lothaire Bluteau, 66 years old, an actor who lives in West Hollywood, Calif., last year enrolled in one of the private plans known as Medicare Advantage. After he was diagnosed with prostate cancer last May, he discovered the specialists he wanted to see weren’t in his UnitedHealthcare HMO’s limited network. He faced delays getting tests and treatment.

He got a bigger shock when he tried to get access to more doctors by switching to traditional Medicare, run by the federal government. Bluteau worried about the steep out-of-pocket costs, so he tried to get a fill-in policy known as a Medigap plan that would cover many of those expenses. Yet health insurers said no because of his cancer diagnosis.

He didn’t realize he could be rejected. “I didn’t inform myself enough,” Bluteau said. “I was so stupid.”

Medicare’s open-enrollment period [began last] Sunday and goes until Dec. 7. During that time, beneficiaries can pick new plans for next year. The options include traditional Medicare from the government, or the wide array of Medicare Advantage plans, which are private-insurance products that wrap in the same benefits.

For those going through Medicare open enrollment this fall, here are five of the biggest pitfalls—and how to avoid them.

Medigap Trap

One of the biggest traps is the one that claimed Bluteau. Patients with health issues may want to move to original Medicare, but they can’t buy Medigap policies. “This is where people get stuck,” said Kata Kertesz, a senior policy attorney at the Center for Medicare Advocacy. “They get really sick, and they can’t switch.”

Medigap, or Medicare supplement insurance, doesn’t have the same rules as most health insurance. For other types of coverage, insurers can’t reject you or charge you more based on your medical conditions. With Medigap, such guarantees are available only at certain times. 

Medigap is vital for many people who enroll in traditional Medicare. The original government program can leave beneficiaries with big out-of-pocket bills for their care, and there is no cap on how high that tab can go. Medigap policies help cover those costs. They have standardized designs, listed here.

Your best chance to get Medigap is when you first join Medicare as a senior, after you turn 65. Then you have a six-month window when you can buy a Medigap policy, and insurers can’t turn you down or charge you more because of your health conditions. 

There are a few other times when you have that federal “guaranteed issue” right, including if you opt out of Medicare Advantage during a limited initial “trial period.” You can find them here. When you aren’t in a protected window, however, you might not be able to get a Medigap plan.

Wrong Doctors

Another common trap that can ensnare people who sign up for Medicare Advantage plans: a lean menu of doctors and hospitals. The plans—particularly health maintenance organizations, or HMOs—can have limited networks that sometimes mean beneficiaries can’t go to the doctors or hospitals they want.

They may also have a hard time getting care if traveling outside their home region.

When Bluteau chose his HMO plan on the advice of an insurance agent, he said, he didn’t realize it lacked doctors he would want to see. He was ultimately able to switch to a different UnitedHealthcare Medicare Advantage plan, a preferred provider organization or PPO, that included them.

UnitedHealthcare said it has the largest national network and a range of plans and “supporting Medicare consumers in finding the right plan is a top priority for us.”

You can find directories of in-network doctors on the insurers’ websites, but be careful. “They can be wildly inaccurate,” said Julie Carter, senior federal policy associate at the Medicare Rights Center, a nonprofit. “It’s a mess, and we don’t really have a great solution other than doing a lot of legwork.”

Don’t just trust—be sure to verify. You should call the doctor offices and hospitals that matter to you, and consider looking up other providers you might need unexpectedly, such as nursing homes. You should call the insurer, and be specific about what plan you are researching and which doctors and hospitals you want.

Paperwork Problems

Medicare Advantage plans can sometimes delay or block access to care. A recent government investigation found some beneficiaries were denied services that should have been covered. You might need to get approval from the insurer before you get a surgery, or a referral from your primary-care doctor to see a specialist. You may also find that those nifty extra benefits touted in ads are extremely limited.

To understand the hurdles, you should look at plans in the Medicare.govtool. As you scroll down each table, you will see small “limits apply” notices next to specific types of care, such as inpatient hospital use or radiology scans. Click on them, and you will find more details about what requirements you might face to get that kind of service, such as prior approval from the insurer. 

Drug Deficits

Your drug coverage can come through a stand-alone Part D plan—needed if you are in traditional Medicare—or wrapped into your Medicare Advantage. Either way, you can use Medicare.gov to see if your prescriptions are included. This is worth doing every year. You may also want to go to the insurer’s own website and look for restrictions on access as well as the “comprehensive formulary” document that lists all covered drugs. Here is an example, and here is another.

Biased Advice                                                                                                            

Be careful where you turn for advice. Ads peddling Medicare Advantage plans may flash pictures of government Medicare cards and include a toll-free hotline that looks official but isn’t the real federal number. Watch out for websites tied to particular insurers or online agencies that may have strong incentives to push certain plans.

A good bet is to favor sites ending in .gov or .org. To find real, impartial information, it is best to start with Medicare’s own website. The State Health Insurance Assistance Program has counselors in every state, and you can find them here—they are typically very knowledgeable. The Medicare Rights Center maintains national helpline. KFF, a health research nonprofit, has helpful background, as does the Center for Medicare Advocacy. Local agents or consumer advocates with whom you have a relationship can also be helpful. 

Here's a link to the full article...

https://www.wsj.com/health/healthcare/medicare-advantage-enrollment-risks-923e7952?mod=wknd_pos1

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Quarterly Update

The third quarter (Q3) of 2023 was negative for the markets and, with the exception of returns through July, there were few bright spots. Core inflation continued to decline during the quarter while the economy remained resilient. The combination of the latter two items led the Federal Reserve to pause raising interest rates during the quarter while signaling to markets that rates could remain higher for longer than anticipated. This theme was prevalent during the quarter and helped push down market sentiment.

Here’s a roundup of how major markets performed during the quarter and year-to-date, respectively:

  • US Large Cap Stocks: down 2%, up 13%
  • US Small Cap Stocks: down 4.7%, up 2.5%
  • US Core Bonds: down 3%, down 1.2%
  • Developed Foreign Markets: down 3.8%, up 7.6%
  • Emerging Markets: down 3.3%, up 2.2%

The AI stock boom that began the year wasn’t strong enough to propel markets through Q3. Ironically, that boom contributed to the selloff in stocks over August and September as investors hit sectors like Technology, down 4% for the quarter, harder than Financials which was down 1.2%, or Communication Services, which was actually up 1%. That sector and Energy were the only sectors positive for the entire quarter. And September saw every sector but Energy down for the month. Even though performance wasn’t that bad compared to history, merely down low single digits, all major indices ended Q3 in “Extreme Oversold” territory, according to my research partners at Bespoke Investment Group. So the tone was decidedly negative regardless of what the final numbers looked like.

Bonds continued their poor performance during Q3. Even though the Fed pressed the pause button on raising short-term interest rates, investors raised them anyway by selling bonds across the maturity spectrum. Long-term bonds were hit hardest, with the typical government bond index down around 13%. Short-term government bonds eked out a positive return of about 0.6%, but the tone grew more negative as we closed out the quarter.

A big part of the negative performance we saw in Q3 was shifting opinions about if or when our economy will go into a recession, how bad it might be, and how high interest rates might rise along the way. This debate has been going on for many months now. Making this hard to pinpoint is that our economy continues to chug along due to a generally healthy consumer, a strong job market, and good momentum in the manufacturing and construction sectors. This, while the Conference Board’s Leading Economic Indicators index has been falling for nearly a year and a half. And the yield curve, a popular and near perfect recession indicator, has been inverted for almost a year without a recession occurring. Maybe higher interest rates haven’t hit home yet and it’s only a matter of time. Or perhaps we’re seeing see the fabled “soft landing” where the Fed raises rates quickly and slows the economy down without crashing it. Not much of this is typical and the general uncertainty amid otherwise favorable conditions is hard for many to reconcile.

And to top it off, investors also contended with another potential government shutdown as we closed out the quarter. Ultimately, Congress was able to craft an 11th hour bipartisan-ish deal to keep the lights on for 45 more days while somehow also generating more animosity and disfunction in its ranks. Unbelievable and believable at the same time, and a sad commentary on the state of our government.

Some good news coming out of all this is that yields on cash are higher than they’ve been in a long time. This has been playing out for many months as well, but deposit rates continued to climb during Q3. As I write, FDIC-insured CDs are paying around 5.5% for a year and this matches up closely with Treasury securities of similar maturity. Now there are viable alternatives to bonds for short-term money, and perhaps also for medium-term money you would like to keep “safe” or otherwise earmarked for specific expenses. Contrast these yields with the roughly 1.6% dividend yield offered by the S&P 500, for example, and we can see where at least part of the pressure on stocks is coming from.

Keep in mind, however, that short-term yields are higher than long-term (that’s the inverted yield curve) so it’s hard to lock in 5+% for more than a couple years without taking on additional risk or other nuisance issues. Additionally, nobody knows where interest will be over any timeframe, so the ability to respond to shifting market conditions is important. Given that, I think there’s absolutely still a place for medium-term bond funds in your portfolio since they should outperform cash if given enough time. Additionally, be wary of moving too much money from stocks into cash for this same reason – we know from history that holding cash in lieu of stocks is a losing bet over the longer-term.

Fortunately for investors we are entering what has historically been the best quarter of the year for stocks, again according to Bespoke. I think odds are good for a decent quarter this time round given the steady selling we’ve seen lately, but the negative tone and rising bond yields from Q3 are still impacting prices as I write. Whatever awaits in the fourth quarter, a little help from the stock market (and from the bond market too!) would indeed be welcome as we close out the year.

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Thoughts on Housing Affordability

Sometimes it’s hard to tell if there’s more news on a topic lately or if it’s just the Great Algorithm in the Sky feeding me more of what it thinks I like. In any case, there’s been (or at least seems to be) an uptick in news about housing affordability in recent weeks.

There are good reasons for this. Here are some that come to mind.

The national average for a 30yr mortgage is now 8%, as measured by Bankrate.com. My system and the Wall Street Journal show it at 7.6%, but Bankrate tends to be a little better at determining loan terms actually available in the marketplace. In the grand scheme of things that’s close to the long-term average of about 7.7%, according to Freddie Mac. That’s small consolation, however, for new borrowers who feel they missed the boat on the sub-3% lows of the Covid-era.

The yield on the 10yr Treasury bond is bouncing around 5%. This imperfect but typical benchmark for mortgage rates has been rising relentlessly but gained momentum in the last month or so, driving mortgage rates higher. This has a lot to do with the Fed raising short-term rates but is also about inflation, expectations for growth, and how parts of our economy and financial markets are still struggling to find equilibrium post-Covid. The bond market is expecting rates to come down a bit in the second half of next year, but not dramatically. Higher interest rates make borrowing more expensive, but how long is a potential homebuyer willing to wait based on market expectations that are often wrong?

Redfin reports that 38% of recent homebuyers under 30 needed family money to cover their downpayment. This is higher than normal but understandable given the circumstances. It’s interesting that these “nepo-homebuyers” (meaning they rely on nepotism – I had to Google it) are still deciding to buy even though affordability is seen as a huge problem.

My research partners at Bespoke Investment group updated their numbers for housing affordability and it confirms the anecdotes – buying a home is expensive! The chart below shows how many hours of non-supervisory average hourly earnings (i.e. blue-collar workers) it takes to save a downpayment when buying at the national average home price. Magnify this by a homebuyer’s personal situation, such as not earning as much while living (or wanting to live) in a more expensive area, and it’s easy to see how unaffordable, or simply unattainable, homeownership can be for many people. That helps explain the nepo-buyers, right? Family help to buy a home is a head start or perhaps a cut in line, depending on your perspective.

Along these lines, analysis from JPMorgan of recent Fed data shows how checking and savings balances by income level have changed from 2019. The light blue is the amount of drawdown from saving stimulus payments while the dark blue is the current balance for low-income to high-income folks, from left to right. JPMorgan talks about how surprising this data is given recession narratives and how this cash savings is part of what’s helping support consumption in the economy. The analysis doesn’t get into the home affordability concept, but it seems obvious where downpayment help is coming from, at least on average.

So what’s my point with all this? Buying and owning a home is expensive, we all know that. Nonetheless, many people still want to be a homeowner and I agree with them. Buying a home is an optimistic act and a commitment to the future that some, for a variety of reasons, aren’t ready, willing, or able to make and that’s fine. However, there’s a sense of security and freedom that comes from owning your home that’s hard to replicate. Yes, I can’t readily move as a tenant can at the end of their lease, but I can buy a dog and paint my walls mauve if the mood strikes, so it’s a fair trade. And it’s not like renting is a cheap option right now anyway. Even as inflation comes down, the relative cost of renting versus buying has remained high. (My opinion on home ownership is biased, by the way, because my wife and I have been homeowners for nearly 30 years after buying our first home at age 19 as nepo-buyers with maybe 3% down and haven’t looked back.)

Financially, after factoring everything in over the long-term, you usually come out ahead by owning versus renting. You benefit from the principal and interest portion of your mortgage being fixed (ideally) because, over time, inflation reduces the size of your mortgage payment relative to your overall income.

You can also expect the value of your home to grow at least by the inflation rate; a default long-term savings plan for your downpayment and monthly principal payments. If your home value grows faster and you make more than that, great! If you’re able to resize later to a nicer but cheaper home while paying down or paying off your mortgage, even better! Contrary to popular stories about people getting rich after mere months of home ownership, these outcomes are absolutely possible but usually take a long time to materialize.

So if you feel ready to be a homeowner, both emotionally and financially, go for it. It’s expensive but that’s normal and often worth it. Graciously accept help from family if it gets you into a home you can build from. Just don’t let yourself be overly swayed by outside opinions and risk overextending yourself. The National Association of Realtors and Redfin suggest you’ll stay in your home from 9-13 years on average, so the first or next home you buy likely won’t be your “forever” home. Be patient as you look for the right fit.

Remember – unless you’re actively flipping homes or are otherwise engaged in the real estate business, your home is your home first and an investment second. Begin with that in mind and you’ll likely be better off as a homeowner.

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A Quick Update

With news of war in the Middle East this past weekend it’s natural for US investors to wonder, and even worry, about potential harm to our financial markets. Setting aside the human toll of violence and war, which is admittedly hard to do, we shouldn’t worry too much about how these events may impact investment values here at home.

That doesn’t sound right, does it? But it’s true. Investors as a group tend to look through most geopolitical events, violence, and social issues with relative ease after quickly assessing the situation and the actual risk to their bottom line. Stock futures tend to open lower on this sort of news, and prices for commodities like oil and gold rise along with Treasurys. Then market wobbles settle down as investors get their bearings. As one should expect, for investors (again, as a group) it’s all about the money. And that’s exactly how things played out in the markets yesterday before all major indices ended the day higher.

Details are still emerging from the weekend along with horrific stories and pictures. A big question as I write on this Tuesday morning has been to do with spillover, not to global markets per se, but the potential for broader conflict across the region. Something like that could certainly roil global markets, or at least mess with the price of oil.

Here’s a quick summary from my research partners at Bespoke Investment Group along these lines. They sent this out yesterday morning. I’ll italicize any emphasis or details that I’ve added since then.

From Bespoke…

Israel-Palestine: On Friday night, Hamas militants breached the border security separating the Gaza Strip from Israel and conducted widespread raids against both military and civilian targets. Despite the entire weekend processing, details are still sketchy but there were unquestionably atrocities committed in the initial incursions. A large number (likely in the hundreds, but as we said details are extremely sketchy) of Israelis have been taken hostage by Hamas. Subsequent strikes against Hamas have also resulted in both military and civilian casualties.

What is clear is that between the Hamas attacks and reprisals by the IDF [Israel Defense Forces] against Gaza, more than 1,100 are dead and that number continues to rise. Israel has formally declared war against Hamas Some geopolitical conflict is relatively unimportant for markets, usually because the risk to systems of production and consumption from those conflicts are narrow. For example, Islamic groups operating in the Sahel don’t impact US equity market earnings. But this conflict has a genuine (if relatively low probability) possibility of large spillover. Israel’s response within Gaza (as well as potential fighting in Lebanon where the IDF has reportedly fired on Hezbollah targets) is not particularly relevant outside markets like the Israeli shekel. What is more concerning for risk assets is the potential spillover to conflict against Iran. Hamas claimed on Sunday that Iran helped plan the attack on Israel, with the IRGC [Iran’s armed forces] providing a range of material and logistical support. That opens the possibility of broadening in the conflict to an Israeli war with Iran, something that would have a major impact on crude markets globally at the very least.

In the mid-20th century, Israel was deeply isolated within its region by the difference in religion (and ethnicity) between itself and its neighbors. But over the past decade, sectarian schism within the Islamic world has driven a change in attitude. Sunni/Shia divisions that were exacerbated by the chaotic aftermath of the US invasion of have re-oriented the priorities of countries like Saudi Arabia and the UAE towards opposing Iran instead of Israel. Iran is also Israel’s highest perceived foreign policy threat given the rank inadequacy of other local countries’ militaries relative to the IDF. The result is that Israel has steadily moved towards accords and normalized relations with a range of the Muslim countries near it, creating a sort of Israeli/Sunni alliance oriented towards Iran. We are overstating the dynamics somewhat for effect, but this is the general direction of travel and trend in the region and frames the risk for markets.

Under normal circumstances one would expect the attack by Hamas into Israel and responses by the IDF in Gaza to generate sympathy for Palestinians from other Muslim states nearby. But if Iran was intimately involved, and Israel decides to prosecute a war against Iran in response (never mind the logistics; Syria, Turkey, Iraq, Jordan, Kuwait, and Saudi Arabia are physically interposed) then it would be plausible to see other Sunni powers side with Israel rather than Iran and opens up the possibility of a shooting war in the Persian Gulf.

We say all of the above not as a forecast (it has a low probability of taking place), but to establish the risk for markets is a broadening of the conflict into a regional war. Without that broadening, the risk premium reflected by stocks, bonds, the dollar, and most of all oil will quickly retreat as is usually the case in periods of geopolitical instability. That should be the baseline. But expansion of an Israeli response to the east (either hinted at in rhetoric or carried out in practice) would have a much bigger impact, and strictly from a markets perspective, that is what should be watched for this week.

And then an update from this morning after much back and forth in the news since yesterday about Iran’s potential involvement…

Overnight, Iran’s Supreme Leader Ayatollah Ali Khamenei denied that Iran was “behind” the Hamas attacks in a post on Telegram. While that does not mean Iran could not have been involved, we have now seen Iranian involvement denied by Hamas, Israeli government sources, Iran, and American intelligence officials as well as spokespeople. That makes the likelihood of the conflict spiraling beyond Israel’s borders now extremely low, a clear-cut positive for risk assets (and clear-cut negative for oil) relative to the initial situation. While we will continue to follow developments, we consider the conflict now to have little short-term impact on markets. As we have previously said, our perspective here is from the very limited lens of analyzing market impacts; the violence and strife will be an important story going forward for other reasons, but one that will not enter our area of focus unless there are significant changes to the facts on the ground.

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The Present Value Dilemma

Deciding to take a lump sum instead of ongoing pension payments is challenging. One option gives you a nice big check with all the associated possibilities and the other option promises years of much smaller monthly checks. Which should you choose? Is there one right answer?

Unfortunately, there’s no one-size-fits-all answer to this question. I have my professional biases and I’ll get to those in a moment. But as with most things financial it’s a facts-and-circumstances sort of issue and your “right” answer can absolutely be different from your coworker who was offered roughly similar terms.

During my time as a financial planner I’ve encountered this question hundreds of times. While the circumstances are often different, there are commonalities that help create a rough framework for how to think about these questions for yourself.

Along these lines I’m including portions of a recent WSJ article on this topic. The author gives her perspective after being offered an early pension buyout by her employer. Her approach is probably the most straightforward I’ve read, so that’s why I’m sharing it with you.

But first I’ll add some of my own thoughts.

Much of the decision process associated with this is emotional and that’s okay. Someone is offering you what seems like more today all at once when the alternative is waiting to receive what seems like less over time. Apparently this is why nearly half of people who are offered pension buyouts decide to take them.

The main problem with this is a lack of appreciation for how time value of money and the present value concept works. In finance, present value implies that money received today is worth more than the same amount received in the future. That seems straightforward so maybe that’s where many people stop. However, money received within a pension framework isn’t the same now or later because it gets adjusted for an assumed rate of return, inflation, or perhaps the yield on a government bond benchmark. This adjustment is meant to equalize the difference between now versus later.

The pension program guarantees your income based on how long they think you and other pensioners will live and how much they expect to make on plan assets along the way. It’s easier for them to simply cut you a check because then they’ll no longer be responsible for providing your income. They back out their assumed rate of return, which is higher these days as government bond yields have risen and mail you your check assuming that you’ll take the ball and run with it. Doing so takes a bite from plan assets but saves money in the long-term as the future value of those would-be payments is higher than the present value check you just cashed, assuming the pension managers invest prudently over time. Who benefits from these potentially higher future values? The retirees who opted to keep their pension.

Assuming you take the lump sum buyout, you’ll want to at least replicate the pension program’s assumed rate of return to come out even over time. If not, you've lost money. If you put your lump sum into an IRA, such as the WSJ reporter says she’ll do with hers, you’ll be taking all the responsibility of being able to pay yourself at least as much as the pension program would have. I don’t have any numbers to back this up, but I’ll wager that most people who take the lump sum and manage things on their own don’t accomplish this.

Because of this over the years I’ve recommended that clients choose the lump sum option less than 10% of the time. I know that most people prefer the sense of security that comes from receiving regular income. I also like them to worry a little less about how their investments are doing. And pension plans usually have lots of participants and assets, so risk is spread around versus the retiree going it alone in their IRA. (Obviously I can and do help manage these dollars for clients, but you see my point…)

So, if it’s “extra” money maybe go ahead and put it in your IRA, invest aggressively and grow it for somebody else, such as your kids or other beneficiaries. If that investment risk scares you or if you’re planning, perhaps ironically, to use the money for long-term income, you’re probably better off leaving the risk on the pension plan’s shoulders.

That said, there are a variety of reasons why taking the lump sum might be an option. Maybe you have other savings and investments to rely on. Maybe you have additional income beyond Social Security, such as rental income, royalties, or all that cash coming in from your encore career as an Instagram influencer. Maybe you have reason to be very concerned about the health of the pension program and it’s not insured by the PBGC (https://www.pbgc.gov/about). Or maybe you favor independence (as I do) and have other plans for the money, bearing in mind that it’s likely all taxable as you withdraw it.

From the Wall Street Journal (a link is below if you’d like to read the entire article)…

A few weeks ago, my former employer offered me a check for nearly $44,000. If I take it, I’ll have to give up a monthly pension of $423, scheduled to start at age 65.

Should I grab the $44,000—or keep the pension?

Deciding whether to take the money or keep the pension requires doing some math and weighing competing risks. Taking an upfront payment—as more than 40% of workers typically do—raises the odds you’ll run out of money in old age. But many workers have pension incomes that lack cost-of-living increases, leaving them vulnerable to inflation…

…Despite significant reservations, I’m taking the upfront money this time. That doesn’t mean you should do the same. Here’s what to consider:

Crunch the numbers

The math frequently favors keeping the pension, said Joshua Gotbaum, former director of the U.S. Pension Benefit Guaranty Corp., or PBGC, which insures benefits when companies terminate pension plans and lack the assets to cover promised payments.

To replicate my pension, I asked New York Life how much it would cost me to buy a deferred annuity that will pay me $423 a month, starting at 65. The answer: $55,531, which means my payout falls $11,531 short of what I’d need.

I could instead invest the money.

Assuming I were to earn the S&P 500’s long-term average annual return of 7.4%, my $44,000 would appreciate to $72,500 by the time I turn 65. Using the 4% withdrawal rate that long has been considered a relatively safe level of retirement spending yields an initial monthly withdrawal of $242. With 3% annual inflation adjustments, that wouldn’t grow to $423 until I am about 84. 

Reasons to keep the pension

Longevity is the main reason I kept my pension in 2015. The longer I expect to live, the more valuable my pension’s promise of a lifelong income.

Steve Vernon, a former pension actuary, advises people to keep a pension if they lack enough guaranteed income from other sources, including Social Security, to cover such basic expenses as food and housing.

A pension also makes sense for those who aren’t comfortable managing their money or might have difficulty doing so in their later years, Vernon added.

My pension is small enough that in the unlikely event my former employer falls on hard times and turns its pension over to the PBGC, my payment should be fully covered. (The PBGC currently insures up to $6,750 a month for a 65-year-old.)

Why I took it

I’m going to take the $44,000 and roll it into an IRA, where it can grow tax-deferred until I start taking required annual distributions at 75.

Why the change of heart?

As retirement approaches, I have a better understanding of our future finances, including other guaranteed sources of income.

Inflation also spooked me. My $423 monthly check seemed substantial enough back in 2015. But thanks to rising prices, I’d need $544 to have the same buying power today. Because my pension is frozen at $423 a month, it is going to buy even less when I’m 65, never mind 85. Having a guaranteed income stream that covers an ever-shrinking share of my future budget doesn’t seem that helpful. 

I hate to admit it, but my decision is also an emotional one. When I consider what my 2015 lump-sum would have grown to had I invested it in the stock market, it is hard not to feel regret. Since Jan. 1, 2016, the S&P 500 has earned a 12.25% annualized return.

To find out how much I’d need to earn on the money to match the promised pension income, I called Brian Tegtmeyer, an adviser in Dublin, Ohio. 

He said if I live to 85, I’d need to earn an average of 5.9% a year on my $44,000 to equal the cumulative income from my pension, assuming I invest my monthly checks and earn the same 5.9% return. If I reach 90, my lump-sum would have to earn 6.6% a year to equal the pension. At 95, the break-even return would be nearly 7%.

Because I’d have to take a lot of investing risk to keep up with the pension, Tegtmeyer recommends sticking with the pension.

But I have a high risk tolerance and I figure 6% to 7% isn’t an unrealistic average annual return to expect over several decades. So I’m going to invest the money and hope something remains for my sons, who aren’t eligible to inherit my $423 pension.

Here’s the link I mentioned… WSJ has a paywall so let me know if you hit it and I can send this to you from my own account.

https://www.wsj.com/personal-finance/retirement/pension-lump-sum-monthly-payment-retirement-f94ad69b?mod=Searchresults_pos2&page=1

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