Are You a Stock or a Bond?: Create Your Own Pension Plan for a Secure Financial Future Hardcover – Aug 27 2008
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About the Author
Moshe A. Milevsky, Ph.D., lectures at the Schulich School of Business, where he earned his Ph.D., and has been nominated for teaching awards. He is Executive Director of the IFID Centre, a nonprofit corporation that is dedicated to research at the intersection of wealth management, personal finance, and insurance.
Dr. Milevsky has published five books and over fifty peer-reviewed articles on pensions, insurance, investments, derivative pricing, and retirement income planning. He co-founded the Journal of Pension Economics and Finance, authored The Calculus of Retirement Income, and has delivered seminars at the London School of Economics, The Wharton School of the University of Pennsylvania, University of Michigan, and universities throughout Europe, South America, and Asia.
Dr. Milevsky recently received a Graham and Dodd scroll award from the CFA Institute in recognition of his research on comprehensive life cycle investing, and in 2006 he was co-awarded a U.S. patent for inventing techniques designed to optimize asset allocation during retirement through the use of life annuities.
Excerpt. © Reprinted by permission. All rights reserved.
Praise for Are You a Stock or a Bond?
"Milevsky guides us through the perilous financial wilderness in pursuit of the promised land of a secure retirement. Milevsky has the rare gift to illuminate abstract financial and mathematical concepts in everyday language and experiences. A must-read in this age of the growing burden on individuals to shoulder greater responsibility for their financial security in retirement."
Steven Siegel, Research Actuary, Society of Actuaries
"The author provides a holistic approach to lifetime financial planning and discusses cutting-edge ideas about how you should manage your asset allocation, demand for insurance, and many other financial decisions. In this book, Milevsky demonstrates his unique ability to explain key financial concepts using down-to-earth language."
Dr. William Reichenstein, CFA, Baylor University
"Milevsky brings much recent research to bear in trying to help people use concepts of modern financial economics in integrated personal financial planning. A key element he brings to the forefront here is understanding the role individual labor income, lifestyle, and longevity play in modern dynamic portfolio theory."
Sid Browne, Ph.D., Brevan Howard Asset Management and Columbia Business School
"This book is a must-read for anyone who desires life-long financial security. Those who read it will have a much deeper understanding of how concepts such as 'human capital' and 'risk management' are not arcane academic terms, but rather concepts that provide an extraordinarily useful road map for creating lasting financial security."
Jeffrey R. Brown, Professor of Finance, University of Illinois at Urbana-Champaign
How Much Risk Are You Really Handling?
I normally don't speak to anybody on airplanes unless it is absolutely necessary, preferring instead to mind my own business, catch up on emails, or fill in paperwork. However, when the attractive, middle-aged lady sitting next to me on the flight from Dallas to Boston asked me whether the article I was reading was interesting, I decided to break my long-standing aviation rule and take up the conversation.
Apparently, Kimberlyor Kim as she preferred to be calledwas flying to a job interview at a large and well-known financial services company headquartered on the east coast. She was rather apprehensive about the interview because the advertised area was completely new to her, and she didn't have much experience or knowledge of the financial industry. Being a professor of finance myself, it was fun and easy for me to offer some tips and trends.
As we chatted, it became apparent that she had recently lost her job at a medium-sized manufacturing company around the Dallas areaa casualty of cheaper labor and products from overseasand was instead trying her luck in a completely different field. Her extensive expertise and knowledge of a particular software program used by her previous employer was of little use outside of the narrow manufacturing sector in which she had spent the last decade of her life. So, she was basically starting from scratch.
To make matters worse for Kim, although she was employed at the Dallas-based company for more than eight years, she didn't have much savings accumulated in her employer-sponsored, tax-sheltered savings plan. The company didn't offer a traditional pension plan, which actually had been frozen years ago. Indeed, the bulk of her tax-sheltered (aka 401k) savings plan had been allocated to one mutual fund and the common stock of the company she actually worked for. Neither of these investments had done very well in the last few years, and her account value was well under the cost basis of the funds. Basically, it was worth much less than the sum of all the money she had ever invested in the plan. The reason she had allocated so much to this one stock is because the company offered a matching deal. Every $100 of salary she deferred and contributed to the 401(k) plan would be matched by the company with $50 of company stock. Effectively, she was getting a 50% investment return on her money, from day oneand it was tax deferred. At first glance, this is a great deal, and many companies offer the same plan. Unfortunately, though, her company's stock price had fallen by more than 60% in the last 18 months, which basically wiped out the gains. In fact, the day she and more than 1,000 other employees were let go, the stock price fell a further 15%, likely because the company announced a major restructuring at the same time.
I obviously felt bad for her, although she seemed to be dealing with her financial misfortune with great poise. She was actually looking forward to starting a new job and perhaps new life working in the financial services industry in Boston. She said it reminded her of graduating from college almost 15 years ago with no savings, no relevant work experience, and a bunch of credit card debt. What a great, positive attitude.
As the flight continued and the conversation evolved, it turns out that she was recently separated from her husband, who coincidently had also been laid off from the same employer on the exact same day. Kim had originally met him at a company picnic a number of years ago, and they had much in common, including a shared employer and career prospects. But, the stress of the dual job loss and the ensuing financial strain had taken a toll on their marriage, and the two of them were in the process of selling their house, which was located a short commute from their old employer, while working out the divorce proceedings.
As if the stress of a job loss wasn't enough, unfortunately, the real estate market wasn't being kind to them either. The house was apparently now worth 20% less than what they had paid a few years ago, and they were having a very tough time getting any offers on the house. I suspected that this difficulty is likely because a number of other residents in the neighborhood, who had also been laid off recently, were also trying to sell their homes at the same time.
Kim was hoping that they would eventually be able to sell the house for at least the value of the mortgage, which, of course, is the amount they actually owed the bank. Otherwise, they might be faced with the terrible possibility of having to file for bankruptcy, or perhaps even face foreclosure. Apparently, Kim and her husband had financed the purchase of their house with an adjustable rate mortgage (ARM) whose underlying interest rate had just been reset to a higher level. The monthly payments were now double what they were two years ago.
As you might suspect by this point in the narrative, I never actually met a Kimberly on an airplane to Boston. I'm sure there are many Kimberlys out there; I just haven't met them yet. I made up her and her very gloomy life just to make a point. Many nice people who have successful jobs, lovely houses, and hefty 401(k) accounts are destined to be Kimberly. They just don't know it yet.
These individuals have placed too many of their life eggs in one basket. They have, unfortunately, allocated their careers, houses, investment portfolios, and even marriages into one economic sector. They have thus violated the most important rule of modern financial theory, and that is to diversify your risk factors. Many people incorrectly believe that diversification only applies and is relevant to the stocks and bonds in your investment accounts. The truth is that it should be applied to anything that has the potential to generate an income or cash flow. Diversification should be applied to all the stocks and bonds in your daily life, not just to your financial portfolio.
In today's volatile economic environment and financial markets, investors are constantly reevaluating their attitude to financial risk on virtually a daily basis. During the times and periods stock markets are in positive territory and increasing in value, the masses believe they are risk tolerant. Then, in the next week, month, or year when markets decline sharply, they decide they are risk averse and can't handle the volatility. They sell out, liquidate, and miss-time the market. Their attitude to financial risk is more fickle than the markets themselves, and risk-aversion becomes an elusive temperament without a solid foundation. It is, therefore, almost meaningless to ask people what their risk attitude is. It changes based on yesterday's market, today's mood, and even tomorrow's weather. How can one make investment decisions regarding hundreds of thousands of dollars based on the answer to a question that changes daily?
This book argues that your approach to financial risk should not be based on a psychological mindset based on your temper du jour, but instead on the composition of your entire personal balance sheet. My main message is that YOU must start approaching your financial situation in a more holistic manner. Your house, your city, your job, your marriage, and even your health is a financial asset that must coexist and be diversified with the rest of the financial assets and liabilities on your personal balance sheet. In this book, I explain why this holistic diversification is so important and how you can do it.
In the past, a financial portfolio of stocks and bonds was more of a perk than a necessity. The investment account was a retirement income supplement or perhaps a part-time hobby. Today, your stocks and bondsvery broadly definedwill become the means by which you will be able to finance and support the last 20 or 30 years of your life. You owe it to yourself to base these decisions on more than "do you feel lucky today?"
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Top Customer Reviews
Most Helpful Customer Reviews on Amazon.com (beta)
numerous ideas that can help you plan to make sure that you do not outlive your money even if faced with another brutal downturn once the workplace paychecks have ceased. "A large sum of money in an investment plan-however you define large-doesn't guarantee you a secure retirement. The strategy you employ and the products you purchase with your nest egg will be more important than the size of that nest egg."-Taken from the Introduction pages and probably the compelling reason why you should give this book a read, and highlight key points for your specific situation, and re-read, re-refer and get your retirement income plan RIGHT!
There are several boring sections in the book and the heavy duty math portions will put most readers to sleep but this book has many great sections such as how the sequence of returns will dramatically effect you, how the elderly have a totally different inflation rate than the standard monthly and yearly CPI, and how the twin problems of that higher inflation rate and increasing longevity can wipe you out if you have not properly planned for them as well as a bad down market. New products have emerged to accommodate the wave of boomers. You must know about them to give your portfolio a fighting chance to make sure that your golden years don't turn to rust."Guarantees make people feel more comfortable", part of chapter 10 is worth the price of the book alone. The chapters just get better and more meaningful as you read along and culminate in the outstanding "Conclusion: Plan for Managing Your Retirement Risks." I have over 20 years experience in the Retirement Planning field, advising only Doctors and Registered Nurses and Physical/Occupational Therapists. This IS the best book currently available on how to establish a "secure financial future."
There is controversy in the profession concerning the allocation of assets considering the nature of a person's source and nature of their income along with those assets. However, putting concepts out there for discussion is how incremental improvements occur. Another controversial approach has been forwarded in Spend 'Til the End: The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire by Laurence J. Kotlikoff and Scott Burns. Their approach is to smooth your spending over your entire lifetime. Dr Milevsky's approach is to determine how to sustain it. The theme of both works is how to evaluate your standard of living and then how to sustain it in the long run.
Dr Milevsky's formula and excel use if very useful for most people. In practice though, most people would have a hard time determining an expected return and standard deviation for their portfolio especially considering this is a value they expect for the rest of their life. Median remaining lifespan (MRL) also means there's a 50/50 chance of living beyond the period evaluated. A person would reduce the chance of outliving their assets if they used a lifespan factor than had a lesser chance of being outlived. He acknowledges the fact that the older you get, the older you are likely to get in Chapter 7. However, he does not provide the mathematical means in his discussion (even as an appendix) to adjust for this factor should one want to plan more conservatively. One may argue that you would adjust the MRL as you age. However, that would mean that a person is overspending early and would need to retrench their spending as they age, because they would need to stretch the spending farther than what the plan called for originally - once retired there is no replenishment of assets that are already spent.
His book The Calculus of Retirement Income: Financial Models for Pension Annuities and Life Insurance goes into greater detail about the calculus that supports this book.
A final note: the use of variable annuities with their riders is, as yet, untested as to whether the companies selling them can withstand the test of time for both markets and demographic forces. Demographic changes are an important consideration since variable annuity riders are structured where people need to pay in more for the benefits than the benefits that are paid out (the theme sounds much like the Social Security or the pension phenomena he describes in his introduction).
Putting the nit noy of these aside, this is an excellent primer for most people about the issues they face for retirement. Using the concepts here will do more good than harm for most do it yourselfers.
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The one thing that gives me pause -- the conclusions his mathematical expertise produce tend to look very bad. For instance, he states in his book that he is 150% exposed to equities. That means he has borrowed 50% above his own money and put it into the stock market. Since the publication date was 2008, you can imagine that his nest egg is totally wiped out, if it wasn't carefully hedged.
As smart as Moshe is, I wonder if he'll write a different book as a result of the "Crash of 2008".
- Mariusz Skonieczny, author of Why Are We So Clueless about the Stock Market? Learn how to invest your money, how to pick stocks, and how to make money in the stock market
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