Pay forward, pay later, pay never

Right now there are six distinguishable generations alive:

                (1) Greatest Generation, people born from 1900-26. We are at the precipice of the disappearance of persons born in this generation. Too little cash-at-hand was the moniker of these people.

                (2) The Silent generation (Traditionalists), people born between 1927-1945. This article will not include discussion of these people, as their financial habits were not unique from their parents.

                (3) Baby Boomer generation, those born between 1946-64. This enormous in number group became mega consumers by learning to use credit (excessively,) changing the way they financed their appetites for a never-ending supply of retail products.

                (3) Generation X, born between 1965-83. This essay will not include comments for this group, as they merely adopted the same, some good and some bad,  financial consumption habits of the previous Baby Boomer Generation.

                (4) Generation Y, Millennial generation, born between 1984-2002. This group is recognized as unique from the previous two generations, not only using more credit, but using it earlier and without a plan for repayment.

                (5) Generation Z, the Digital Generation, those born after 2002…Enough time has not elapsed to judge the financial habits of this generation, but it is probable that they will be an extension of the Millennial generation.

                Without discounting the existence of the Silent Generation, the Generation X or the newest on the scene Generation, let’s look at how persons in each of these generations: Greatest Generation, Baby Boomer, Millennial, have dealt with financing their own lives. It is these three that have financial behaviors that are uniquely distinguishable from each other.

                The first of these is The Greatest Generation, so named by Tom Brokaw in his recent book of the same title.  All of the their Baby Boomer children have heard their stories of the Depression and World War II so many times , many actually believe they lived through them! This was definitely a “cash and carry” crowd, probably to a fault. Living through the ’30’s Depression without credit cards or access to other institutional lending choices forced these people to pay-as-you-go for virtually everything.

              Too much individual suffering during these desperate financial times and feeling the pain from the second traumatic American event in their lives, World War II, stimulated this generation to vote for government assistance programs like Social Security Retirement and Disability, Guaranteed VA health insurance and college assistance, and the crowning glory of Medicare. Remember that Medicare was a product of this Greatest Generation, as the Baby Boomers were not yet at an age to enter the voting booths in 1965. When recalling the distress these people encountered during these two terrible American events, we can can agree that  this generation did indeed “pay forward” for the government benefits they legislated and eventually enjoyed.

                After the Greatest Generation’s second tragedy, WW II , the Baby Boomers showed up. Their children, the Gen X’ers & Y’ers, are justifiably sick of the listening to their Boomer parents stories about growing up in the care-free ’50’s or being part of Woodstock’s sex-drugs-rock & roll ’60’s. This generation caused Marketing Departments to blossom in America. Starting with Proctor & Gamble commercials on early TV shows (soap operas) and progressing to offering senior living choices, uncountable companies have tried to appeal to the buying habits of this massive 76 million number of people.

                Starting in the 1960’s, while still in college, the first in this generation began to learn about credit. Innumerable choices for borrowing for college, retail purchases, cars, and housing emerged. This generation converted from “cash and carry,” taught to them by the previous Greatest Generation of parents, to a “pay later” habit of  consuming. Just as too little credit was a liability for their parents’ financial stability, too much credit became a financial liability for the Boomers. Ultimately, too many of them lost their houses or ended up in bankruptcy (a taboo to be avoided at all costs by their parents) when the first financial crisis appeared.

                Lastly, the children of the Boomers arrived, this current combination of Gen X’ers and Y’ers. Without trying to differentiate the sociological differences of these two unique groups, let’s look at the way the latter ones, the Millennial, view financing their lives. It seems that they have been convinced, en masse, to accept massive debts before they even graduate from college. Combining this with the unparalleled expense of buying houses, cars, & on-the-go food choices, and keeping up with owning the newest electronic gadgets, it seems possible that far too many of this Millennial group may never get out of debt. Recently, a significant percentage of them are disappointingly beginning their careers in either part-time work or with no job in sight.

               The same level of opportunities may not seem as evident to these persons  as when their Baby Boomers parents looked for employment and seemingly could show up at a job interview and “simply make fog on a mirror” to get hired. The new norm for this Millennial generation is living at home into their ’30’s, allowing their parents to keep them on the company health insurance until they age 26, staying on the family auto insurance policy as long as the agent allows, using the family cell phone plan, and expecting to receive some kind of help with first their house down payment.

               While the financial pages list many new 20’s aged “tech billionaires,” and those that studied math-engineering-science-tecnology are doing fine in the workplace, it seems certain that the new moniker for the Millennial Generation will become the “pay never” crowd. History may record that too many of them had no opportunity to pay forward or even pay later, as their helicopter-parents did virtually everything for them as they grew up and that they were given too much support when the financial-job crisis of the last five years arrived. This generation has watched banks, insurance companies and auto manufacturers be bailed out from too much debt. They are digesting that people in bankrupt Greece and Detroit are still somehow afloat and continue to receive promised pensions and other government assistance.

                Perhaps they should not be faulted from expecting that some miracle will eventually bail them out.

Tulip bulbs or bubblegum?

It may be a decent time to recall Tulip Bulb Mania from Dutch history of the 1600’s. When the tulip contract market became primary to the overall Dutch tulip industry, limitless differentiations such as coloration, size and supposed rarity began to dictate price variations in tulip bulb contract purchases. While growing popularity and demand were contributing factors to increasing prices, “flippers” drove reasonable prices to skyrocketing levels. By the time tulip prices peaked in February, 1637, one single tulip bulb demanded ten times a normal worker’s annual income.

As more and more people insisted on participating in rising prices, tulip contracts even began to be traded on the London Stock Exchange and in Paris, too.  Eventually, defaults on contracts began the bursting of the bubble and markets plunged, resulting in an economic depression that lasted years for the Dutch.  A few people made a lot of money during the rise of tulip prices. But, like any other subsequent bubble-mania, the last-ones-in experienced financial losses that impacted the rest of their lives.

American history books record a couple of eras not unlike Dutch Tulip mania: the 1929 stock market mania-crash and the Dot.com bubble of the late 1990’s. Human behavior is the driving force of manias like these. Hopes of financial profits or locking in prices before inflation erodes purchasing power are both good reasons to pay over-market prices for a product. However, greed sometimes overcomes reason and causes people to pay unreasonable prices for some goods.  Just as fear of further loss may cause a person to sell a product at a less than reasonable price, greed may cause the converse behavior.

The truth is that no one can predict the size of a bubble before it explodes. Only AFTER it bursts are we able to see that it had grown too large. All of us can remember the aftermath of sticky bubblegum on our faces after we had pushed just one more breath of air into the magnificent bubble on our lips. The consequence was messy…ick!  And after every burst bubble,  we promised  to stop just a breath short of the explosion the next time.

Today’s drinking fountain discussions include these subjects: seemingly endless supply of new global investors, companies-countries whose growth appears limitless, impossible-to-comprehend computer trading activities, far above-average recent portfolio gains, apparent impossibility of normal market corrections, inconceivable size of financial product universe. …

Is it possible to be satisfied BEFORE the last breath is blown into our next bubblegum bubble?

Today, you need to be a TWENTYmillionaire!

I spent most of my life dreaming of being a millionaire. When I was a boy,  everyone my age was mesmerized by the television show, the MILLIONAIRE. A rich guy walked to the door of a financially struggling family and, POOF! That person was now a millionaire. None of us were foolish enough to believe that could ever actually happen, but many of us did spend the next 50+ years trying to become one.

In the last few decades, I wore out many hand-held calculators by building future value computations that resulted in my becoming a millionaire. In quiet conversations with my colleagues and best friends, we discussed the value of that million dollars and we all fantasized about the security it would provide us in our retirement. In the mid-1980’s, a million dollars would provide ample income if invested in a risk-free treasury bond. Furthermore, a person did not need to go very far out with maturities to get a reasonable yield. Let’s review the 30 year history of the 2 year Treasury Note yields and subsequent income on a ~$1,000,000 investment.

                1984:  ~12%        $120,000 @ year income

                2007: ~4.5%          $45,000 @ year income

                2013: ~0.22%           $2,200 @ year income

It becomes more mind-boggling when you do some simple reverse math and calculate the amount necessary to invest today in a two year treasury note in order to produce the same income as a one million dollar two year treasury note yielded in 1984: >~$54,545,545! We could include inflation as a factor included in establishing the value of $120,000 of income today as compared to 30 years ago.  If we assumed an average annual inflation of 4% for the past 30 years, our calculations would reveal that it would be necessary to have ~$3,500,000 spinning off 12% income to provide similar purchasing power as the same $1,000,000 did in 1984.

But, ladies & gentlemen, this is NOT $54 million. What happened? Today, a meager millionaire  investing  $1,000,000 invested in a two year treasury note is required to “step out of the box” and do something entirely different with his-her money to be able to expect a reasonable retirement income. Looking back just a few years, at 2007, we can see that a person could still get ~$45,000 annual income from a two year riskless treasury note. Again using reverse math…today, a person needs ~$20,000,000 invested in an identical two year treasury note to provide the same $45,000 annual income.

Differences in riskless rates of return that are this magnificent are producing at least four behavior choices for retirees and persons nearing retirement: (1) continue to use riskless investments  and consequently spend additional principle each year to maintain the same life style. (2) continue to use riskless investments, but protect principle by reducing life style costs, (3) continue to use riskless investments, but working longer or returning to the work force to provide additional monies for retirement costs, or (4) change investment philosophy and now utilize investments that have market risk in order to provide retirement income for now or later.

Decide what your risk tolerance is BEFORE changing your investment philosophy. Make sure to understand that systemic (market) risk of vehicles like common equities not only have the benefit of rising in value, but they may also decrease in value for reasons unimaginable today…terrorist bombs, CEO fraud, geological or meteorological event, legislative or regulatory changes, etc. Know that providing for a riskless retirement is a lot more difficult today than it was just a few years ago.

And good luck becoming a TWENTYmillionaire!

Wake up, Rip! Understand Regression to the Mean

An important mathematical concept is regression, sometimes called reversion, to the mean. Investment professionals usually recommend that people implement a buy & hold strategy and disregard daily values of portfolio ingredients, like individual stocks or managed accounts like mutual funds. Most of the time and especially over long periods, like decades, this is may be a reasonable plan. This blog will explore another mathematical truth that could reveal a short-term “selling & buying back” tactic, different from the traditional Rip Van Winkle, go to sleep for a long time, buy & hold strategy.

In an earlier blog,  Are You Normal?, I reviewed a day from high school freshman algebra… mode (highest frequency), median (exact center point of a range of measurements), and mean (statistical average). Most investment results are reported as means; that is, when we look at returns of more than a year, like 3yr-5 yr-10 yr-etc, the number is reported as an average of the compounded annual returns. Here’s an example, using $100,000 as the original investment:

2010 return: 20%…$120,000 new value

2011 return: 0%…$120,000 still value

2012 return: -10%…$108,000 end value

3 year average return: +2.60%

Using a Texas Instruments BA II Plus hand-held calculator will show that the 3 yr average (mean) annual gain is 2.6%. Make sure to understand that this number is an annual average compounded return. (If you need to better understand the difference of averaging simple interest rates from compounded rates, refer to my blog, Time a Valuable Commodity.) How could we react if this portfolio now has a sudden three-month increase of 15%? Since the mean 3 year annual gain is 2.60%, the math of large numbers would predict that the portfolio would eventually regress back towards the 2.60% mean (average). While no mathematician is able to predict WHEN the portfolio will regress, it is reasonable to expect the portfolio to eventually do so.

This mathematical game is more valid when using longer periods of time to calculate the mean, or average return. Certainly, a view of a 10 year return is a truer evaluation of average performance than a three year look, as in our example. But, in the end, looking at short term losses or gains, like three or six months, and comparing them to longer-term means or average portfolio returns may expose an opportunity. In our example, the 3 year mean return was +2.60% and the short-term three-month gain was +15%. This may indicate a selling/re-buying opportunity. If one did exercise this tactic and “moved to the sidelines” with this part of the portfolio, in order to capture a real alpha (advantage), it is important to keep sight of near-term numbers and re-purchase the same stock or manager when the value dips to a lower number. The same tactic may be used if you stock or portfolio decreases by an amount greatly different than the mean… only your action would be to buy, then sell at a higher price, the converse of the example we used here. Either of these tactics are referred to as executing a “round trip,” which means doing both a buy and a sell to capture a net gain (or loss).

Very few people use this tactic because they are taught that no one is smart enough to pick “tops & bottoms” in markets. I employ this method of portfolio management only a few times each year and I am not always right. If anyone wants to use this short-term trading tactic, make sure to “do the math,” be patient and get the advice of an investment professional to guide your transactions.

Wake up Rip, use your math, and look for opportunities to use regression to the mean! You can apply it to predicting behavior in other parts of life, too; i.e., forecasting rain, your son or daughter’s GPA, or budgeting. Let your imagination take you to other areas…age expectations, surprise events (near-Black Swans), macro climate changes, etc. I hope you have as much fun and can actually add some “alpha” to parts of your life as I have done in understanding the math of regression to the mean.

The fiscal little hill

There seems to be little continued interest in the mechanics of whether or not Congress will eventually raise the debt ceiling. Today, a report of the GNP in the USA showed a slowdown and the likely suspect was said to be temporary sequestering of some budget items, including military expenses. By the afternoon, the markets had shrugged off the lower GNP and resumed the countdown towards reaching all-time highs for both the DOW and the S & P. What’s the deal?

My timing of reading various analysts opinions and listening to retail investor conference calls paid off this week. On one conference call, an analyst proposed a chronology for a series of events that will unfold in the next few months, all of which are calendared by our Congress to meet, discuss, and finally vote on raising the debt ceiling. After hearing this person give a detailed description of possible outcomes, including negative impacts on our economy and accompanying equity markets, it was clear to at least me that almost no event or no date matters at all anymore.  We have finally reached a point of information saturation.

What this actually means is that we may have arrived at a place where the fiscal cliff has morphed into a little hill and is, to quote a noted purveyor of economic forecasting,  “…a known unknown…that is; any additional information can no longer influence the markets…”  TMI (too much information) has numbed all of the public and most of our Congress. Very few care about important dates that previously indicated hard lines-in-the-sand by opposing politicians. Informationally, most agree that we are merely walking in the footsteps of similarly reported critical dates by naysayers and doomsayers regarding Greece’s debt issues.

Here we are today in a back-to-normal mode. Virtually everyone cares more about the upcoming Super Bowl, why Red John draws the smiley face on  “Mentalist”, or who will win the next American Idol. During the election cycle of 2012, some Americans appeared to care and a few may have even got to a point of beginning to understand the possible long-term consequences of the $16 trillion (and growing) national debt.  But rest well tonight, my friends. This subject has faded into the archives of useless information and is permanently filed under “what was that all about?”  When we all wake up some day much later in all of our lives, as Rip Van Winkle did after twenty years or so, maybe someone will dust off this file and bring it forth as noteworthy for discussion again. Until then…party on!