Reuters Article: No quick exit from the West’s economic malaise

An article today by Reuters looks into why it is taking so long for the West to start growing at a decent rate. The arguments are very intriguing and makes for a good read for any investor looking at retirement, as it provides an insight on what the world may look like a few years from now, in particular in terms of what may happen to interest rates or where investment opportunities may lie.

It argues that there are two main causes at the root of the West’s stagnation:

1-      a glut of global savings, which depresses interest rates (too much money makes it cheap)

2-      a shriveling of income accruing to labor in the Western economies, which depresses consumption

Both causes can be tracked down to China, which has amassed $3.7 trillion in reserves, and has depressed the cost of labor as it has grabbed the lion’s share of the global production of manufactured goods at rock-bottom prices.

The consequences of these factors are huge. For starters, it forces central banks to keep lowering interest rates down to zero, essentially eliminating the main instrument that monetary authorities have to revive economic activity and fight against quickly falling inflation.

The zero-rate policy also has propped up asset prices, which benefit the rich and widens the income gap. This, in turn, depresses consumption even more, making corporations reluctant to increase production and instead making them more likely to hoard cash. This increases the glut of savings and keeps the pressure on interest rates in a perverse feedback loop.

The conclusion of the article is that the solution to what ails the West cannot be found in monetary policy alone. The West’s problems are rooted in social, political and demographic causes that cannot be tackled by financial means.

The article ends on an optimistic note. Read it here:

http://www.reuters.com/article/2013/11/29/us-economy-global-stagnation-insight-idUSBRE9AS03O20131129

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How should I choose between a 403(b), a 457(b) and a Military Thrift Savings Plan?

I answered this question on Nerdwallet.com:

How should I choose between 3 available retirement investing options through my and my wife’s employer (none of which offer matching)? I have 3 options: 403(b), 457(b) and Military TSP.

Answer:

While all these plans are tax-deferred, they have different withdrawal rules.

457(b) plans let you withdraw money whenever you are separated from service regardless of age; if you are not separated from service you cannot withdraw the money without penalty until you turn 70 1/2. The 403(b) plan does not let you withdraw the money without penalty regardless of whether you are separated from employment, but you can start withdrawing after reaching 59 1/2.TSP withdrawal options are somewhat more complicated. Visit the TSP site for specific information.

Here is great publication by the IRS that summarizes differences among various plans, including the 403(b) and the 457(b) plans.

Here are three things to watch out for:

1) There are exceptions to the withdrawal penalty – on 457(b) plans, due to “unforeseeable emergencies” and on TSP and 403 plans due to “financial hardship”, a somewhat less restrictive criteria.  Some events are considered “financial hardship” but not “unforeseeable emergencies” – for instance, recurrent negative monthly cash flow. If you think you might face an emergency in the future, you may find that accessing your savings without penalty is not as easy on a 457(b) plan.

2) Since both 403(b) and 457(b) plans are tax-deferred, you will pay taxes only upon withdrawal. Make sure that you read the 457(b) plan documents carefully to see what will happen if you are separated from service. Funds in a 403(b) typically stay in the plan until you decide to take them out. But 457(b) plan documents may contain something like “all funds will be distributed to the employee after separation from service unless that employee notifies in writing within 60 days that he (she) wishes to maintain their funds within the plan.” If you are not aware of this and receive a big fat check then you could incur a nasty tax liability.

3) Make sure that you have a reasonably broad choice of investment options and, most importantly, that you can tailor them to your needs. Many plans try to make it easy for participants by pre-packaging a bunch of funds and call each package “aggressive”, “moderate” or “conservative”. These monikers may lead you to believe that your are somehow protected against losses when in fact you are not. If a “conservative” allocation is too heavy on bond funds, for example, you may end up losing money as interest rates go up.

Try your best to understand the options that are available to you on each plan and make sure you have flexibility in allocating your hard-earned money. Ideally, you may want to seek the help of a financial advisor to help you decide how to choose among the options that are offered within each plan.

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What’s the best way to measure the level of risk in my portfolio?

I answered this question on Nerdwallet.com:

What’s the best way to measure the level of risk in my portfolio? I own a number of stocks and a few mutual funds, but with the market this high, I’m thinking about bringing down my risk.

Answer:

The best way to measure risk on a portfolio is to estimate how much you are exposed to losing and assign some type of probability to that loss. This is what investors really want to know, and portfolio managers call it “drawdown”.

The academic literature, on the other hand, measures risk as “volatility”, or the kind of price vibration that an asset exhibits around a trend. So defined, cash has no risk because it never changes value, while anything else is risky as long as its price moves more or less unpredictably.

At first glance it seems that both are very different measures of risk, although it can be shown that there is a close, but not perfect, relationship between volatility and portfolio drawdowns. So measuring one gives you a good idea of the other.

Let’s focus on volatility. The volatility of a portfolio that contains many assets like yours is the result of the aggregate moves of the individual stocks and mutual funds. Since most do not move exactly in unison, the extent to which they correlate is important. If all move together, then you are not “diversified” and will be at high risk of being whipsawed. If instead all move in ways that cancel each other out, then you have no risk whatsoever but most likely no return either, because all positive moves are cancelled by negative moves.

Here is where it gets tricky. Many of the tools that you would find to measure the volatility (or risk) of your portfolio are based upon how assets have historically moved against each other, and those measures are averaged over long periods of time.

But the fact is that correlations move a lot.

In a stable, steady market, you can find value by picking this asset class or the other. If a panic ensues, all assets are for sale and you will lose a lot of value even if you thought you were diversified. Correlations are typically low in bull markets (when you least need low correlations) and high in bear markets (when you most need low correlations). I think you seem to have a “gut” understand of this because you are concerned that the market may take a nasty turn and all your assets may tank together. This is a valid concern.

There is nothing wrong with bringing down the level of risk in your portfolio from time to time as long as you understand that it may cause you to miss out on potential returns if the market goes up and you do not participate in future gains.

But you need to be very careful not to eventually become a “market timer” trying to constantly adjust the risk exposure of your portfolio.

This is what we do for a living. We do not “time the market” but rather keep an eye on how correlations behave over time. High or increasing levels of correlation may indicate that portfolio protective measures, such as increasing cash, could be advisable.

Good luck!

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