Financial Professionals Winter 2023

This is my quarterly e-mail missive (affectionately dubbed “the massive missive” by one of my readers) intended primarily for my fellow financial professionals wherein I share items I have run across or thought about this quarter which I think might be beneficial to you. Enjoy!

First, a post, “Thinking About the Next Warren Buffett” is recommended. I should note that although Uncle Warren had a good run:

  • You have to include data prior to October 1983 for the BRK alpha vs. the S&P 500 to be statistically significant.
  • BRK has cumulatively tied the S&P 500 (total return) for over 20 years; the net outperformance all happened before 8/31/2002.
  • Since 10/31/2008 the CAGRs have been 9.5% (BRK) vs. 12.1% (S&P 500). I cherry-picked the start date to make the point, but still …

(I did this calculation a few months ago so data is as of 9/30/22.)

Second, a client told me recently that he feels like this is the market bottom and wanted to be more aggressive. I told him markets aren’t expensive, but they aren’t cheap either. I didn’t go into the math for him, but thought I would for you – don’t you feel special?

The PE on the S&P 500 as I write this (trailing twelve months) is 18.42.  PE ratios regularly (though not recently) decline into the single digits. (In reverse chronological order we had single digit PE ratios in: 1984, 1977-1982, 1974-75, 1953, 1947-1952, 1940-43, 1937, 1932, 1923-26, 1916-21, 1907, 1877, and 1873-74.) To get down to 10 the price would have to drop 46% from here. That assumes the “E” stays constant. In reality, a debacle (even just sentiment) bad enough to drop prices that much would certainly lower earnings as well. So the downside risk on U.S. stocks from here is probably more like 60%. I don’t think the odds of that happening are all that high, but it’s still good to keep in mind what can happen even if you don’t think it likely.

Third, this is months old now, but in case you somehow missed it, the IRS issued rules around the missed RMDs if a client inherited an IRA recently.

Fourth, on sustainable withdrawal rates (SWR), one new paper that is getting a lot of press is here. It argues the 4% rule is too high. I’m skeptical; you can get 1.42% real on long-term TIPS right now and at zero real you would have a 3.33% SWR given a 30-year life expectancy (with principal depletion) because 1/30 = 3.33%. At 1.42% real return, if we assume no volatility (these are inflation-protected bonds, so very low vol is not a large error), then we solve (in Excel) PMT(0.0142,30,-1,0,1) = 4.06%.

So we have 4% just using a TIPS ladder! (I realize you don’t build a ladder just out of long-term bonds; shorter maturities have similar yields though so this is entirely possible to do right now.)

Fifth, good list of advisory firm differentiators here. Customer service shouldn’t be a differentiator, but unfortunately in today’s world it’s seems hard to find. Read about “unreasonable hospitality” here.

Sixth, how Americans spend their money by age group:

Seventh, there is an old Wall Street aphorism that “they don’t ring a bell” to indicate market tops or bottoms. Here is a recap of the news on March 9, 2009. That was the low spot. (h/t Ben Carlson)

Eighth, some new research (brief, full paper) has implications for planning how long our clients will be able to work and how much they are likely to make. Obviously, heavy cognitive task jobs can be done at older ages than manual physical jobs. The “nonroutine” category probably has better compensation also. In addition, if it is “routine” it is probably more likely to be automated out of existence. I do not know why the curves for nonroutine cognitive analytical task intensity have a different shape for white men vs. white women. I suspect (but do not know) it may be a cohort effect. In other words, 70-year-old white men were doing those types of jobs 30-40 years ago and continue to do them, but 70-year-old white women were not doing those types of jobs 30 years ago so are still not doing them. That is just a guess. This commentary does not appear to consider that cohort effect.

Ninth, “Save like a pessimist, invest like an optimist” is my all-time favorite Morgan Housel adage. It’s from this. He also has a new piece with other great wisdom here and did an interview here.

Tenth, we are well past the point of needing this resource, but I saw it mentioned recently and it looks pretty good: The Fundamentals of Writing a Financial Plan.

Eleventh, four questions to ask prospects here. I particularly like the first two:

  1. How do you each define the term “wealthy”?
  2. If you’re wildly financially successful, how much do you want to give to or leave to your kids?

Twelfth, I’m sure you have heard plenty about the recent legislation that contained “Secure Act 2.0” but I thought I’d share with you what I sent our clients a few weeks ago:

The Consolidated Appropriations Act, 2023 is 4,155 pages (available here).

The pertinent part with financial planning and tax implications (the so-called SECURE ACT 2.0) is 359 pages (pages 2046-2404 of the bill).

The “summary” of that portion is 19 pages (here).

Following is my attempt at a much shorter recap of the provisions that are likely to affect some of our clients. I’m obviously leaving a lot out, but probably not anything that will affect you (or the changes are ones for which we already have work-arounds). However, YMMV!

Section 107 – The age at which Required Minimum Distributions (RMDs) from retirement plans must begin has been increased from 72 (which was itself an increase a few years ago from the long-standing 70½) to 73 in 2023. It further increases to 75 in 2033. This change does not affect things such as the age 70½ milestone to make Qualified Charitable Distributions to charities from IRAs.

Section 108 – The IRA catch-up limit (the extra $1,000 you have been able to contribute if you are 50 or older) will be indexed for inflation (in $100 increments) going forward.

Section 109 – Starting in 2025, if you are 60-63 the catch-up on your 401(k) plan (which is $7,500 for 2023) is increased to 150% of the normal catch-up for those four years. (Probably – there is some confusion about how this will actually work.)

Sections 116 and 117 – We have just two clients with SIMPLE plans, but for those with those types of plans the contribution limits will increase starting in 2024.

Section 603 – The qualified plan catch-up (i.e., the $7,500 for 2023 mentioned above) must be made to Roth accounts (i.e., you can’t make those contributions on a pre-tax basis) starting in 2024. This only applies to employees with compensation over $145,000 (as indexed for inflation going forward).

All of the changes above are good ones, except the last one. None of the changes (good or bad) have large impacts. As I said at the outset, there are many more provisions, but they aren’t likely to affect you. Please let us know if you have any questions on any of this, but we will automatically incorporate relevant changes in your planning, etc. as the provisions become effective.

If you are interested there is some light reading on the original Secure Act, see here.

Thirteenth, a paper on cognitive decline here. This is a good summary:

[A]dults of today should on average reach functional impairment thresholds and be diagnosed with dementia at later ages than their same-aged peers in the past – yet, not because age has been kinder to them but only because the declines started from higher levels [i.e., Flynn effect].

Fourteenth, some examples of how people became millionaires here. $1mm net worth doesn’t seem like much of an accomplishment anymore, but still interesting stories.

Fifteenth, Larry Bird’s philosophy of money here. An excerpt:

Some of the guys who made far less than me bought the $700,000 homes, and the Rolex watches, and the big luxury cars. I used to tell them, “You’re crazy, you should be saving your money.” They’d just laugh and make jokes about me stashing my money away. But I could see what they were doing. They were throwing away their future. So many of them were living for today and not even stopping for a minute to think about ten years down the road when their playing careers were over and the money stopped pouring in. And by the time they realized what I was telling them was true, it was too late. I can’t tell you how many ex-teammates have asked me for money. It’s heartbreaking for me to say no, but I do because I warned them. I told them to save.

Sixteenth, excellent literature review on the momentum factor here.

Seventeenth, J.P. Morgan released updated Long-Term Capital Markets Assumptions. It’s basically 8% on U.S. Stocks and 4.6% on U.S. bonds with 2.6% inflation (all numbers geometric). So, a 60/40 would be about 4% real! That’s nice.

Eighteenth, there have been several large lottery jackpots recently. I thought I’d do some math on it as an “investment.” As I write this the Mega Millions lottery has an estimated jackpot of $1.35 billion. The cash value is $707.9 million. The tax on that would be about 37% + 5.75% (in GA) for a total of 42.75% (the number is so big, I just ignore the lower tax brackets, as they won’t help much at all). So, if you won and took the cash balance, you would net $707,900,000 * (1 - 0.4275) = $405,272,750.

The odds of winning are 1 in 302,575,350. You divide the cash by the odds to get the expected value of a ticket:

$405,272,750 / 302,575,350 = $1.34

Since tickets are $2.00, every purchase has an expected return of minus 33%.

So, as you may have heard, a lottery is just a tax on people who are bad at math.

Of course, it has entertainment value, but it has negative intrinsic value entirely due to the taxes! If it weren’t for income taxes, you would have a nice (expected) return of:

$707,900,000 / 302,575,350 = $2.34 / $2.00 - 1 = 17%

Taxes reduce the expected return from a positive 17% to a negative 33%.

(There is another catch too. You could split the pot.)

Nineteenth, there is a belief circulating on the right that Biden has severely restricted domestic oil production. The pandemic dislocations muddle things a little, but oil production is always higher under Biden vs. the same period in Trump’s term. It’s also higher than Trump’s term on average but that is due to the pandemic fall; I don’t think it is fair to give Biden credit for that. But it’s clear there has been no collapse, to the contrary production has been trending up consistently since Biden took office (source data).

Twentieth, articles on Traditional Medicare vs. Advantage Plans here and here.

Twenty-first, I tout the value of reading a lot. Then there’s … this. Maybe not reading is the only way to get and lose $16 billion! I’ve always preferred reading to listening. I’ll always read (or at least skim) a white paper, and never do webinars. A new study gives some rationalization for that preference, at least if you want to process the information analytically.

Twenty-second, of course The Onion nailed crypto investing:

Man Who Lost Everything In Crypto Just Wishes Several Thousand More People Had Warned Him

CHICAGO—Saying he had been absolutely blindsided by the sudden change in his fortunes, local 33-year-old Tyler Branton, a man who lost everything in cryptocurrencies, told reporters Thursday that he just wished several thousand more people had warned him. “If only a thousand—or even a few hundred—more friends had told me about the risks of putting my entire savings into Dickcoin, I might not be where I am today,” said Branton, decrying how no one had alerted him to the inherent instability of digital currencies except for dozens of coworkers, family members, podcast hosts, and respected economists. “Over the past few days, I’ve started to worry that all of this stuff—Web3, non-fungible tokens, even the blockchain—is just a Ponzi scheme to cheat people like me out of our money, and no one even thought to explain this to me outside of the hundreds of people I deliberately ignored. It’s really a shame that I learned all of this too late.” At press time, the relieved man had reportedly thanked social media users who spoke up to encourage him to shake off the bankruptcy and go into debt buying as many Golden Banana tokens as possible.

(More crypto jokes here.)

ECB take on crypto is here. The whole (short) post is worth reading, but here’s a taste:

The value of bitcoin peaked at USD 69,000 in November 2021 before falling to USD 17,000 by mid-June 2022. Since then, the value has fluctuated around USD 20,000. For bitcoin proponents, the seeming stabilization signals a breather on the way to new heights. More likely, however, it is an artificially induced last gasp before the road to irrelevance – and this was already foreseeable before FTX went bust and sent the bitcoin price to well below USD16,000.

Finally, perhaps Cryptocurrency is the Segway of finance.

Twenty-third, if you are interested in long-term house price trends, see this. Click the “National Prices” tab and hover over the area you want to see.

Twenty-fourth, most regretted majors, and the opposite, here.

Twenty-fifth, private equity (fake) valuations were recently discussed by The Economist and Cliff Asness.

Twenty-sixth, I talk, and link to, a lot about the dangers of overconfidence, but here is a good post that correctly points out the other side. I don’t want to be overconfident about the issues with overconfidence! (Or maybe it’s confirmation bias I am fighting against at this point.)

Speaking of overconfidence:

An unbiased appreciation of uncertainty is a cornerstone of rationality – but it is not what people and organizations want. Extreme uncertainty is paralyzing under dangerous circumstances, and the admission that one is merely guessing is especially unacceptable when the stakes are high. Acting on pretended knowledge is often the preferred solution. – Daniel Kahneman

Finally, my recurring reminders:

J.P. Morgan’s updated Guide to the Markets for this quarter is out and filled with great data as usual.

Morgan Housel and Larry Swedroe continue to publish valuable wisdom. Just a reminder to go to those links and read whatever catches your fancy since last quarter.

That’s it for this quarter. I hope some of the above was beneficial.

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