The New Retirement Model

John Mauldin | Thoughts from the Frontline
March 18, 2005

It seems like every week I get a letter from a reader asking questions along the following line: "How can I make a lot of money so I can retire early and/or live the lifestyle I want to live when I do retire?" Most of them are phrased far more eloquently and with accompanying questions and comments, but the bottom line is, "How can I get rich?"

I'm especially touched by the very sincere letters from young people who ask this most basic of questions about accumulating wealth. They are not looking for get-rich-quick schemes but for some guidance as to how to organize their lives. I've never really been able to answer these letters with anything close to an adequate response. In today's letter I'm going to draft a response that we can use for all such future letters. I trust you will find it interesting as we wax a little philosophical about how to build wealth.

Today's letter is in part a reflection of two very different items which reached my desk this week. The first is a rather interesting survey on retirement from Merrill Lynch. The second is a remarkable new book by my longtime friend Michael Masterson simply entitled "Automatic Wealth." Both of them got me to thinking about retirement (not mine, of course!), and how the coming wave of baby boomers entering their retirement years will have a massive effect on all aspects of American society.

The New Retirement Model

Merrill Lynch released a new survey a few weeks ago called the New Retirement Survey, wherein they polled 3,448 baby boomers, both from the general population and the more affluent segment about their views on retirement. I'm going to spend a few pages summarizing the survey, and highlighting some of the more interesting points. I should note that the survey was done for Merrill Lynch by gerontologist Dr. Ken Dychtwald, who is the president of Age Wave with the help of Harris Interactive. I must say that I thought it was a very thoughtful and well put together survey.

The survey reveals that baby boomers plan an unexpected approach to retirement in anticipation of increased life spans, labor demographics and (what I perceive as a lack of) financial preparedness. Interestingly less than 1/5 of baby boomers plan to stop working for pay. 40% expect to cycle between work and leisure; another 16% plan to work part-time and an energetic 13% plan to start their own business. 6% plan to continue to work full-time.

That is a long way from the model of our parents and grandparents, who more or less expected to retire from work. Interestingly, of those who expected to continue working, 56% of them said that they intended to pursue a different line of work.

Not having enough money was only fourth on a list of fears about the future. Number one on the list was being unable to afford health insurance, with over half of those responding worried about health insurance. Right after that was a major illness and going to a nursing home.

Money Can Buy Happiness

The survey broke the respondents into two groups. Those who were very or fairly well prepared for retirement and those who are somewhat or not prepared. Those who are more financially well-off were twice as likely to be looking forward to retirement, 70% more likely to be optimistic about the future and three times as likely to describe themselves as successful. Coincidentally, they expected to live longer, and were happier.

Those with less money were twice as likely to be stressed out; 50% more likely to worry about health care; much more worried about losing their sex drive and three times more worried about whether or not they would have enough money. Evidently, money can buy some relative amount of happiness, at least among the broad population.

The United States is currently in a great debate about Social Security. We are basically ignoring the far larger and more contentious issue of Medicare, and this survey tells us why. When asked the question, "Do you believe that you and every member of your generation are entitled to the full benefits of each of these programs?" 89% of boomers believe that they are entitled to Medicare. Social Security was only slightly less at 88% and senior discounts scored 85%. 78% believe that we are entitled to prescription drug coverage.

The Republicans have offered a plan whereby nothing changes for the baby boomer generation, recognizing that trying to change the benefits for those over 55 is a nonstarter politically. Given the serious anxiety about health care among the boomer generation, when we do get around to having to deal with Medicare the choices are going to be few and difficult. But there is some consensus about what those choices would and would not be.

72% of respondents favored reducing entitlement levels of those who are financially well-off. 63% opposed having everyone receive a little less in the way of entitlements and 65% opposed raising the age of eligibility to reflect higher life expectancies.

As an aside, I think this means we do relatively nothing about Medicare until there is indeed a crisis, forcing a solution. Given the above and some of the statistics below, I think it is highly likely that the "rich" are going to have to cough up (pardon the pun) more of their income for health care for everyone else.

Unrealistic Retirement Expectations

Those were pretty much the general conclusions. I've found some of the actual survey questions and responses to be very interesting. 42% of baby boomers do not know how much money they will need to be able to live comfortably in retirement. 60% had less then $100,000 of total savings other than their home, and 46% had less than 50,000. Of course 7% were not sure how much they had saved and 12% decline to answer, so it would be a reasonable assumption to think that 70% had less than $100,000.

26% felt they would need between $25,000 and $50,000 annual income to be comfortable in retirement, and another 27% would need as much as 75,000. (23% were not sure what they would need -- so much for financial planning.).

Let's look at that last group. To generate $75,000 of income, with a reasonable degree of safety and adding enough to principal to be able to take care of the effects of inflation, you need a portfolio worth about $1.5 million, give or take $100,000. Only 2% of the respondents said they had as much as one million. Only 3% had more than $500,000 with another 5% having more than $250,000. Less than 10% of the boomer generation had more than $250,000, yet 70% said they would need more than $25,000 annual income to live comfortably.

Even subtracting for Social Security and other pensions, there are going to be a lot of baby boomers who are going to be disappointed about their retirement if they have to live off their savings. To our credit, we seem to recognize that. Thus, less than 20% of us expect to be able to enter retirement without working for pay again.

Nevertheless, we are an optimistic lot.

We as boomers like to think of ourselves as a generation that defies categories, yet we sometimes fit into them so well. Dr. Ken Dychtwald broke the boomer generation into five clear "profiles of boomers and their likely retirement scenarios emerged. These profiles provided further insight as to what the "next stage" looks like for these boomer groupings; the personal, societal, workforce and economic implications of their perspective. The five distinct and different boomer segments are: the "Empowered Trailblazers," the "Wealth-Builders," the "Leisure Lifers," the "Anxious Idealists," and the "Stretched & Stressed."

The next few paragraphs are direct quotes and descriptions for these five groups from the survey. It might be interesting to see into which groups you fit.

"For the Empowered Trailblazers (18% of boomers), retirement will be a well- rounded, empowered and liberated period of their lives. Rather than spending their retirement in passive rest and relaxation, they will be traveling, exercising, taking educational classes, spending time with family and friends and embarking in new directions. Open to new ideas, retirement will provide an opportunity to widen, not narrow, their horizons. Generous with their resources, they plan on contributing time and money to social causes and charities. 68% are looking forward to next phase. More than half say 'self-confidence' and "open- mindedness" completely describes them. 90% aspire to work, 67% plan to volunteer, and 79% plan to travel.

"The Wealth Builders (31% of boomers) are fueled by their desire for material success and security. For them, retirement will center around continued work and the achievement (and enjoyment) of financial success and security. They are the most likely of all groups to define themselves as workaholics and are less likely to say they want to stop working for pay in the next phase. About half of this group would say they are primarily driven by their own personal financial gain, while the other half is working to achieve financial security and stability for their immediate family. In fact, they are the most likely of all boomers to describe themselves as family oriented, and in the next phase they plan to reap the benefits of their hard work by spending more with their spouse or partner, children, and grandchildren. 79% plan to work, but only 28% say a sense of self-worth or identity is a very important reason to keep working - it's the money that matters.

"Anxious Idealists (20% of Boomers) see their retirement years both as a time for new directions and better work/life balance and as an opportunity to give even more of their time, skills and money to worthwhile causes. They may not have a lot of assets, but they are the most likely to say it's important to them to leave a significant amount of money to their family and to charitable organizations. However, because throughout their lives, they have not tended to focus on practical matters, they realize that they haven't put away as much money as they should, and their lack of money is a serious and growing source of worry and fear. 85% believe that it costs too much to retire.

"When asked what they are looking forward to, the Leisure Lifers (13% of Boomers) are the most likely to list simplifying their lives and having years of full time relaxation and play among their top goals. Work is definitely not a priority for them - and a large percentage never enjoyed their careers or jobs. They are the most likely to look forward to stopping work for pay completely and permanently, and the sooner the better. They are more likely to say they will retire by their early 50s. In fact, half of them are retired already. With low levels of income and low levels of savings, if they were to anticipate serious financial difficulties in the next phase, they are the least likely to say they would go back to work to try to make up for the shortfall. Instead, they are counting on government entitlements and their savings to ensure a life of leisure in the next phase. 78% are looking forward to having more time for rest and relaxation, and 71% are looking forward to reducing stress. 94% feel that they and every member of their generation are entitled to full benefits from social security.

"The Stretched and Stressed (18% of Boomers) are the least likely to describe themselves as successful, self-empowered or optimistic about the future. They are on a bad path and they know it. During the next stage, they will continue to work, not because they want to, but because they will have to. Of all boomers, they have the highest unemployment levels, have earned the lowest levels of income throughout their lives and have taken least advantage of available guidance or pension opportunities. There isn't much they are looking forward to - they are least likely to look forward to spending time with their spouse, most likely to think financial issues and where to live will be major sources of disagreement, and most likely to think they and their spouses will be very unhappy in the next phase. Only 9% are looking forward to next phase, and they expect lowest levels of happiness (5.8 out of 10). They expect to live the shortest - only until age 77."

Automatic Wealth

Looking at the data, it's easy to come away with the idea that a substantial portion of my generation is living in denial or has not planned or saved for retirement. But it is also true that a significant portion has done very well and will be able to retire in comfort. What's the difference? It's not necessarily education or genetics or luck, although these don't hurt. It has more to do with hard work, perseverance and a lifestyle that allows for significant savings.

When someone writes to me asking how they can make a lot of money, what they're really asking me, as a supposed expert in investing, is "What are the secret investing techniques that the wealthy know that I don't?"

And now I have to burst a lot of bubbles. There are no secret investing techniques that will make you wealthy. The not-so-secret answer is to save as much as you can and compound it as safely as you can over time, and start when you are young.

I spend a great deal of my time analyzing hedge funds and money managers. Some of these funds and managers provide above-average risk-adjusted returns, but there are very few who will make you rich simply by putting your money in their fund. And those who do have such funds are probably closed to new investors. We all know that putting $100,000 with Warren Buffett at the beginning of his career would have made you fabulously wealthy. But who knew back then? How many people had access to Warren Buffett or even knew who he was in the 1960's?

The reality is that 80% of mutual funds managed by professionals don't beat their respective indexes. Very few managers have consistently provided 15-20% annualized returns over a decade of time, which is a remarkable achievement.

Investing is about managing your assets in such a way as to have them grow and compound. That implies you have assets to begin with. This means that saving is more important than investing in the process of accumulating wealth.

I know, I know, there are many examples of people who have in fact gotten rich investing. They found Warren Buffett at the beginning of his career or invested a significant portion of their assets in Microsoft in 1982. If you start with 10,000 investors, it is quite likely that you'll find 100 who have become wealthy simply from the process of investing. As Nassim Taleb noted in his brilliant book "Fooled by Randomness," that is no more than you would expect simply from random events.

People do indeed become rich by buying a two dollar lottery ticket. It happens every month. It just doesn't happen to very many people.

People who get rich by random investing often resent it when I suggest that they were lucky. I mean this as no disrespect. As my less-than-sainted Dad often said, "I would rather be lucky than good." But for everyone who chose Microsoft, there were a lot of who also chose Wang. Both investors did their homework, and initially, it looked like they were both going to be successful. Things just worked out differently.

And I would point out that Buffett and Microsoft were risky bets in the beginning. I mean, have you seen a picture of the 7 scruffy kids who started Microsoft? This is a slam dunk?

Those who invested in Wang simply saw it is bad luck. Those who invested in Microsoft believed in their own skill. And I would admit there was some skill. But history shows us that it is not a very reproducible skill. If it truly was a skill then such a person would be choosing one Microsoft after another. And that happens very rarely.

There are some 70,000 investors who trade a hypothetical $1 million at the web site www.marketocracy.com run by California investor Ken Kam. Only 2% have records of beating the S&P both long-term and monthly. Kam picks the top 100 managers to actually run a fund. However, last year, the fund lost 4% while the S&P 500 gained 11%. It's a tough world out there.

Listen to how Rich Karlgaard of Forbes describes these top 100 investors: "Few of Kam's top 100 attended Harvard Business School. That's the point. Wall Street investment houses, says Kam, recruit the wrong people. The top-drawer firms look for high achieving, well spoken generalists from the best business schools. But good investors, Kam says, tend to be savants with a passion. They're nerds. They're freaks. They're too young or too old. They eat junk food and stare at the monitor and perhaps forget to bathe. They live and breathe stocks. They tend to be sector specialists who know the underlying science, product cycles, supply chains and b habits in their sectors."

In the very important book, "The Millionaire Next Door," one of the things that is quite common among millionaires is that they own their own business. And I would suggest to you that most of the people that you and I know who have gotten rich because of their investing have done so because investing is their business. They are investment professionals in one form or another. They may not have a "license," but they are professional none-the-less. They have devoted their lives to it. I contend they would have been just as successful in another business. It was their hard work, dedication and devotion to their craft that made them successful. Investing was simply a tool.

For 98% of the people who read this letter, investing in a passive manner is not the primary way to get rich. You will have to do something in addition to investing if you want to be able to retire wealthy.

And that brings us to the book that I mentioned at the beginning of this letter by Michael Masterson called "Automatic Wealth - the Six Steps to Financial Independence."

It would be simple to say that from now on when I get a question about how one can become wealthy I will refer them to "Automatic Wealth." But the book is more about than some formula for getting wealthy. It is to some degree a book about the philosophy of wealth and money, as well as the role it plays in our life.

The Eight Habits of Wealthy People

Michael recognizes that money is not the most important thing in life. As he notes, he knows a lot of rich people who are miserable. However as the survey we just reviewed pointed out, not having money is even more stressful. Money is simply a tool. And some people seem to have the knack for accumulating it. Masterson gives us eight habits of wealthy people.

A. Wealthy people work hard.
B. Wealthy people are good at what they do.
C. Wealthy people have multiple streams of income.
D. Wealthy people live in (relatively) inexpensive homes.
E. Wealthy people are moderate in spending.
F. Wealthy people are extraordinary at saving.
G. Wealthy people pay themselves first.
H. Wealthy people count their money.

Michael recognizes that there are multiple ways to achieve wealth. It is possible to achieve wealth by working for the other guy and getting paid a handsome salary and save a good part of that salary. And he shows you how to increase your salary and your personal value to your company. But statistics show us that it is more likely you will achieve wealth by owning your own business, investing in small businesses and/or real estate.

I've known Michael for over 20 years. He is one of the smartest businessmen that I know, and is a true marketing genius. (I don't say that lightly.) Watching him analyze a business or marketing strategy can be a very humbling experience. During the time I've known him, he has started dozens of small businesses and ventures. Most of them have been successful and some of them have been wildly successful. Michael has a knack for understanding what it takes to make a small (or large) business work. This book gives us the accumulated wisdom that he has learned in the past almost 40 years.

But this book is not to just about starting small businesses. I happen to be a serial entrepreneur, but there are many people who simply don't want to run their own business. I can respect that, but it doesn't mean that they are locked into a life of less wealth. Michael gives us many other ways to go about accumulating wealth.

I am a relatively successful businessman. While reading this book, I learned a great deal about the basics of business and organizing my life. I took away a lot of notes and added to my "things-to-do" list. The four hours I spent reading this book will repay themselves many times over. Moreover, the book is written in such a style that it has me positively excited about making changes that I know will be difficult.

So if you're starting out and looking to accumulate wealth or, if you're already down the road and would like to fine tune or add to your knowledge, I suggest you go to www.Amazon.com and pick up "Automatic Wealth." I really think you'll find the $16.47 (and four hours worth of reading time) price tag to be a bargain.

Masterson and his staff also write a daily newsletter called "Early to Rise." The e-letter is full of ideas and articles about not only business but how to make your life in general better. I find it a valuable read, and always try to at least scan it for the articles that I know I need to think about. I've arranged for my readers to get a free trial by going to http://earlytorise.com/freetrial.htm.

Fishing, Business and Real Cheerleaders

We are going to take my youngest son fishing tomorrow, although it may scar him for fishing. I am the world's unluckiest fisherman. I can sit in the middle of 20 people catching fish, use the same lures or bait, throw my line in the same place and come up empty. It is uncanny. I have been known to jinx professional guides. Some of my friends have banned me from their camps. Of course, Trey will probably only remember the time his Dad took him fishing and not that all they did was drown worms. At least, that is what I hope.

Thankfully, I do not make my living fishing. What I do is analyze hedge funds and investment managers. And since we are talking about small business and the need to market, let me in the way of a commercial mention that I write a free e- letter for high net worth investors.

I am instituting some new policies and procedures for my free Accredited Investor E- Letter, which we will announce soon. It is a letter on hedge funds and private offerings. In the meantime, if you are an accredited investor ($1,000,000 net worth or more) and would like to get my thoughts, you can go to www.accreditedinvestor.ws and register. Basically, I work with Altegris Investments to be able to offer investors access to a select group of hedge funds, private offerings and commodity funds. The website explains how we work, as well as outlines the risks involved. Feel free to write if you have more questions.

I wish I could make the offer more universal, but the rules do not allow me to do so. I hope that at some point in the future Congress will decide there should not be two classes of investors, but until that time the rules are quite clear. (In this regard, I am the owner and a registered representative of Millennium Wave Securities, LLC, an NASD member firm. See more disclosures on the web site and at the end of this letter.)

I am often disdainful of stock market cheerleaders. Usually, when I get a little over the edge, someone writes and points out that I should not disparage REAL cheerleaders. They are right, of course. I have four daughters, all of whom were involved in competitive cheerleading. It is a lot of work and effort. One of my daughters (Amanda) was an All-American. Tomorrow morning she will be in Dallas cheering for ORU at the women's NCAA tournament as ORU takes on the University of Texas in what on paper a mismatch. But in March, upsets sometimes happen. That's why they play the game.

It's time to hit the send button, as it is late and I have to get up early. Enjoy your week.

Your not planning on retiring analyst,

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