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How Much Is In Your Neighbor’s IRA?

This piece originally appeared on The Rich Investor.

The Individual Retirement Account, or IRA, is the backbone of most middle-class Americans’ retirement plans.

Creating the tax-deferred savings vehicle back in 1974 was one of the few unequivocally good decisions Congress has made over the past half century.

Don’t give Congress too much credit though.

An infinite number of monkeys slapping their hands on an infinite number of keyboards will eventually pound out the entire unabridged works of William Shakespeare if given enough time.

By shear random luck our fearless leaders are bound to do something right once in a long while.

But that’s not my point today. This is…

Properly using an IRA’s tax benefits can vastly accelerate your savings plans.

For many Americans, the tax benefits, compounded over a working lifetime, might make the difference between retiring in style or having to move in with your adult children in your golden years.

This isn’t academic for me.

I keep the vast majority of my liquid savings in assorted IRAs, Roth IRAs and similar vehicles.

I’ve done the math and I know that, based on my return and tax rate assumptions, the tax benefits increase my annual returns by 20% to 40%.

At any rate, let’s take a look at how Americans as a whole are using their IRAs.

You can use it as a measuring stick to see how you’re doing relative to your peers, and to see if you need to make any changes.

The Employee Benefit Research Institute (EBRI) published a report earlier this year that looked at account balances, withdrawals, contributions and asset allocations for American IRA investors over from 2010 to 2015.

Interestingly, 87.2% of IRA owners did not contribute a single new dime to their accounts over the six year window, whereas only 1.8% contributed every years.

But before we throw the proverbial low-saving American spendthrift under the bus, I should point out that a lot of these IRAs were probably owned by retirees or by workers who weren’t eligible to contribute because they were (hopefully) squirreling away fresh savings in their company 401(k) plans.

(I say “hopefully” because various studies have shown that only about half of all Americans contribute to a 401(k) plan…)

The more interesting number to me is that, among those who did contribute new funds to an IRA, roughly half maxed out their plans. Good for them!

Not surprisingly, account balances jumped over the 2010 to 2015 period, as the stock market shot higher.

The average balance of investors that owned IRAs for the entire period rose by 47.1%.to $146,513.

But here’s where it gets interesting.

Few investors earn the “average” return, and actual results are scattered all over the place.

The bottom 25% had cumulative returns of just 0.1%, essentially earning nothingover a period of time in which the market was on fire. Meanwhile, the top 25% saw their balances explode higher by 87.3%.

This brings me to asset allocation.

If you didn’t make money between 2010 and 2015, it means you weren’t playing the game.

You were likely sitting in cash, having been shell-shocked by the 2008 meltdown.

And indeed, EBRI found that 27% of IRA owners had zero invested in stocks over the six years covered.

About 17% were fully invested in stocks over the period. The “average” account had roughly half its assets allocated to stocks, with the precise number bouncing around between the mid-40s and mid-50s.

Now, it’s easy to scoff at those who sat in cash over those six years, missing an epic run in the market.

But some of these investors were likely in or near retirement and didn’t want to risk a major drawdown.

And I’ve always said that the most important thing is to simply get the cash into the account to take advantage of the tax break. The allocation can follow later. I reiterate that point here.

But all the same, you shouldn’t be sitting in cash earning nothing. If you can’t accept the risk of a large allocation to stocks, you should at least have your cash in bonds, earning something.

Alternatively, you could consider using my Peak Income service, which is designed specifically to produce higher yields than what is generally available in the mainstream bond market while having a low correlation to the stock market.

The average yield on our current open recommendations is around 7%, which doesn’t include capital gains.

The larger takeaway isn’t that Americans are irresponsible spendthrifts who lack the discipline to save (though certainly there are millions of Americans that would fit that description).

It’s more an issue of Americans trying to be responsible but not quite getting the execution right.

The good news is that this is a much easier problem to fix. Once you’ve done the hard work of saving, allocating your funds well is the easy part.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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How to BE the Insurance Company

I wrote a few weeks ago that the economics of writing options (i.e. selling options that you intend to let expire or buy back at a lower price) are a lot like those of an insurance company. Yes, there are risks, and insurance companies do take losses from time to time. But those risks can be managed, and — let’s face it — insurance company failures tend to be extremely rare. So long as people are willing to overpay to protect themselves from disasters, insurance will be a profitable business model.

Well, my friend and colleague Lee Lowell picked up the torch and took those comments a little further last week in the Rich Investor. Below is an excerpt from his article. Enjoy!


How to Pull in Cash Just Like an Insurance Company

by Lee Lowell

Do you ever think about all the money you pay to insurance companies each year? I wouldn’t blame you if you didn’t.

I mean, there’s car insurance, home insurance, renter’s insurance, life insurance, medical insurance…

It adds up. We just assume that’s part and parcel of living in the modern world, so we grin and bear it.

Fact is, I’m pretty sure that in your lifetime, you’ll never make a substantial claim from your insurance company. (Here’s hoping!)

Sure, you might get into a minor fender bender or have a leaky roof that can cost a few thousand dollars to fix. And, if that happens, it’s almost a guarantee your premiums will go up.

You’ll fork over even more to your insurance company each year.

But where does all that money go?

Right into the insurance companies’ pockets, and whatever’s left over heads to their shareholders.

Again, insurance companies are insuring you for things that almost certainly won’t happen. They’re banking on low-probability events, and they’re raking in the cash.

I was thinking about insurance when my colleague Charles Sizemore recently answered a question from one of his Peak Income subscribers.

The reader asked Charles’ opinion on whether the timing was right to start buying put options on the Dow Industrials.

Here’s how Charles replied:

As a general rule, I don’t buy options because they’re too speculative for my style of trading.

Due to the time decay of options, you have to get the timing just right to make money buying call or put options.

Some investors choose to buy put options as portfolio insurance. As a general rule, I do not.

I think about it like this: I buy homeowners insurance because my house is a large piece of my personal net worth, and I have no other practical way to hedge the risk of a disaster.

The insurance is expensive, and I hate paying it. It irks me that my insurance company profits off of my fear.

But, again, I pay the insurance because I don’t really have a choice.

Portfolio insurance is different. I have choices.

If I’m worried about a market crash, I can set a stop-loss or simply sell some of my stocks and raise cash.

I don’t need to buy expensive put options that will nearly always expire worthless.

But while I don’t buy put options, I do often sell them.

If done correctly, selling out-of-the-money put options can be a conservative income strategy. Rather than paying insurance premiums every month, I’m more like the insurance company that collects them.

Charles hits the nail on the head.

Over the years, I’ve seen this same question and given the same answer many times. Charles also echoes everything that I’ve been writing in these pages so far in terms of selling put options.

Remember: Insurance companies are insuring you for things that almost certainly won’t happen.

That’s the secret sauce!

But, as Charles says, he pays it because he has no choice.

And that’s true. We have to pay it, right? We just can’t take the chance of being without it if disaster strikes.

What if you could turn that dynamic on its head so that it’s you collecting cash?

I’m here to tell you those same principles are at play when you sell out-of-the-money (OTM) put options – and doing so can bring in lots of money in the process.

How so?

When you sell an OTM put option to someone, you’re collecting their premium upfront (just like insurance companies) while offering them insurance against an event that most likely won’t happen – specifically, a very large fall in the stock price.

But as long as the stock doesn’t fall to the put-option’s strike price (a very unlikely occurrence), you keep the whole premium at expiration.

Take Amazon (AMZN), for example.

It currently trades at $1,880 per share. I recently wrote about how you could get paid upfront premiums – and keep them – as long as Amazon doesn’t fall to $370 per share.

The odds of that type of fall happening? Practically nil.

Still, someone who owns the stock is looking for some kind of insurance against it falling in price, even all the way down to $370.

How do they do that? They buy a put option that allows them to sell the stock to someone else at a price of their choosing.

It’s peace of mind for them. So, they buy the insurance.

Who’s the insurance company in this case? The put-option sellers! Put-option sellers offer the insurance and collect the premiums. And they can do this year-round.

The key to making consistent money from this strategy?

By deciding where the stock is most likely not going to fall to.

It’s a much different concept to ponder. Most stock and option buyers are always trying to figure out where the stock is going.

But put-option sellers are basing their trades on where the stock isn’t going. Huge difference, and the odds are well more in their favor.

Better yet, you can sell these sorts of options on hundreds of stocks each month and collect thousands of dollars in the process.

The key is picking an area where the stock has such a low probability of falling. That’s how you decide which put option to sell.

You’re in complete control. You choose the stock and you choose the strike price level.

But how do you know where a stock most likely won’t fall to?

You do your research just like any other investor. You look at stock charts, you check the stock’s fundamentals, and you use a secret weapon like a probability calculator.

Pick a point where the stock has very little probability of falling to. And then sell the corresponding put option. You’ll collect the premium and if the stock doesn’t fall to that level by expiration, the money is yours free and clear. Wash, rinse, and repeat!

And what if the stock does in fact fall to the level by expiration?

Well, this might be the best part – if you picked a high-quality stock to begin with, that means you’re scooping it up a ridiculously low price. Can you imagine getting your hands on Amazon for $370 a pop? Do you think it’d stay at the level for long?

My best advice for anyone wanting to sell put options: only execute this strategy on stocks that you feel would be great to own at below-market levels.

That way, if you do in fact end up owning the stock, it’s still a win!

In short, stick to your favorites, and stay the heck away from companies you don’t care about.

When you concentrate on selling put options on levels where the stock won’t fall to, you’ll see your win rate skyrocket.

This is how the insurance companies play the odds. It’s about time you did, too.

This first appeared on The Rich Investor.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Tiny Houses, Tiny Wallets

This post originally appeared on The Rich Investor.

My buddy Ari was a self-made millionaire by his early 30s. But he didn’t earn his nest egg the way you might expect.
It seems like most of the young and well-to-do hit the jackpot by writing a popular app or creating a viral YouTube video.
That’s not Ari. For a young guy, he made his money in a surprisingly old-fashioned manner: building an empire of mini-storage units, strip malls and other steady income-producing properties.

(Ari looks old fashioned too, by the way. Despite being a Millennial in his mid-30s, he wears a three-piece suit and wingtips to the office every day. Give him a fedora, and he’d look like my grandfather circa 1940.)

Ari is my go-to “real estate guy,” the person who can reliably give me a boots-on-the-ground account of what’s happening in the property market. So I asked him the other day about the health of the Dallas apartment market. Everywhere you turn, there are cranes and construction crews throwing up towers full of luxury apartments.

“It’s a joke,” Ari deadpanned. “Most barely break even. They’re just looking to sell to a private equity fund and take the money and run.”

That might sound like a flippant answer, but Ari was just getting started.

“This property market is a house of cards, bro. Look at the trend of microapartments. Do you think anyone actually wants to live in one of those? They do it because they can’t afford anything bigger.”

Ari’s phone rang, and that was the end of the conversation. But he left me with some good food for thought.

In case you’re not familiar with them, “microapartments” are tiny one-room apartments of 50 to 350 square feet. Your toilet doubles as living room chair. They’re that small. (I’m only slightly exaggerating.)

Microapartments are billed as a great option for the young and trendy. They are tiny and thus eco-friendly. You’re not cooling or heating a lot of unused space. They tend to be located in urban areas close to public transportation and close to bars and other entertainment options.

All of that sounds great. But again, your toilet is doubling as a living room chair.

And living within walking distance to your job and to your local Starbucks matters a lot less when you can actually afford a car.

I think Ari was on to something.

So much of what is viewed as eclectic Millennial behavior – microapartments, not owning a car, the “sharing economy,” no immediate plans to marry or start families, etc. – has a lot less to do with the fickle preferences of the young and a lot more to do with them struggling to stay afloat financially.

Let’s look at the broader housing market.

Since 2000, the Case-Shiller 20-City Composite Home Price Index is up 111%, and this includes the major collapse in home prices starting in 2006. In most markets, home prices are at new all-time highs.

Average wages, in contrast, have risen a little over 50% in that same period (neither data series is indexed for inflation).
You don’t have to be a math whiz to see that it’s a real problem when housing prices have more than doubled while wages of the would-be buyers of those houses have risen by barely half.

Given this, it’s not surprising that something as ridiculous as a 50-square-foot apartment is now fairly common.
Most of our readers tend to be professionals that are well advanced into their careers, so if you’re reading this it’s pretty unlikely that you’re living in a microapartment and taking the bus to work.

But if you also want to save your children and grandchildren from that fate, teach them to save and invest early. They don’t have to swing for the fences. Regular, disciplined investment into a portfolio yielding 6% to 10% will grow a nest egg quickly, at any age, really.

Investing just $200 per month will grow to a nest egg of well over $30,000 in 10 years if invested at 6%. That number jumps to nearly $40,000 if invested at a 10% annual return.

If you can convince your child or grandchild to start saving like that at age 20, they’ll have plenty of cash on hand to make a nice down payment on a proper house.

I can’t make your kid save. But in Peak Income I can help them (and you) grow their savings steadily and conservatively through some of my favorite long-term income producers.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Competing with the Quants

I was having a drink a while back with my friend and fellow Rich Investor contributor John Del Vecchio, and we were reminiscing about how much this business has changed since we started our careers.

John is a forensic accountant who knows exactly where to look in the financial statements for accounting shenanigans; where “the bodies are buried,” so to speak. I call him the “Horatio Caine of finance” after David Caruso’s character on CSI: Miami. John has the same no-nonsense demeanor.

The late 1990s were a fantastic time to be a short seller. With the internet bubble entering the final blow-off stages, a disciplined forensic account had an almost unlimited supply of short candidates.

But you had to know what warning signs to look for. This often meant spending hours digging through the footnotes of a company’s income statement, cash flow statement and balance sheet.

Back then, John spent 10 hours per day on the LexisNexis database, pouring over every line of a short candidate’s financial statements. And often, it would all be for naught. Not every investigation ended with a perp walk.

Today, John presses a button and his system does the heavy lifting for him in a matter of seconds.

When the system finds irregularities, John still has to roll up his sleeves, put on the green visor, and dig into the books. But his quantitative system saves him hours (if not days) of exhausting research.

And the 1990s weren’t all that long ago. Let’s go a little further back in time.

Benjamin Graham – Warren Buffett’s mentor and the man that invented value investing as a discipline – made a fortune in the 1930s and 1940s by doing painstaking research.

He’d dig through the financial statements and calculate valuation ratios (price/earnings, CAPE, etc.) by hand.

As early as the 1950s, after Wall Street had starting hiring armies of analysts to do the same work, Graham had started to question whether he could still find bargains using his old methods.

By the 1970s, Graham has more or less given up and converted to an efficient market advocate.

Warren Buffett is most famous for owning large positions in household names like Geico and Coca-Cola. But earlier in his long career, Buffett literally walked door to door in Omaha asking little old ladies if they were interested in selling their paper stock certificates to him.

In today’s world of instant stock trading on your smartphone, that seems ridiculously quaint and old timey.

Fundamental investors have flocked to quantitative tools to help them pick through mountains of data faster than their competitors.

Forbes even coined a term for it – “quantimental” investing.

But is more data always better?

That’s a lot less certain. Last week, Bloomberg reported that quant funds are “reeling from the worst run in eight years.” AQR – considered one of the best quant managers in history – is down nearly 9% this year in one of its flagship funds after suffering a miserable June.

There are so many points to be made here, it’s actually hard to know where to start. But here we go…

1. You can’t realistically invest today without using at least some basic quantitative tools.

There are simply too many stocks to research and not enough hours in the day. Not all of us are crunching numbers using computers designed for NASA, of course. But even something as basic as a simple screen or ranking system can narrow your universe to a manageable size.

If Ben Graham were alive today, he wouldn’t be calculating ratios by hand after digging the numbers out of a quarterly report. It’s also highly unlikely he’d be using the same screening criteria that he recommended using in the 1930s.

Graham was a smart guy, and he would have evolved with the times, probably coming up with new ratios we’ve never heard of.

2. You’re never going to be able to compete with the big boys in technology investment. 

The biggest Wall Street banks and hedge funds really do use computers that were designed for NASA and have teams of PhD eggheads to run them. You can’t realistically compete with that, so you have to play a different game.

Look for opportunities in small- and medium-sized companies that the big boys can’t realistically touch. (A large fund can’t take a meaningful position in a smaller company without moving the market.)

3. Beware of false correlations. 

I wrote a couple months ago that butter production in Bangladesh was statistically proven to be the best predictor of U.S. market returns.

Now, this is obviously a quirky coincidence. No rational human being would really believe that dairy production half a world away makes a dime’s bit of difference to the stock market here.

But quantitative investing is full of little traps like these. So before you trade, your screen needs to pass a “smell test.”

If the criteria seems farfetched (seriously, Bangladeshi butter?) it’s likely that you’re mistaking statistical noise for worthwhile information.

 

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Why Would You Live Stream Dental Surgery on Instagram?

My sister-in-law, Malu, is the baby of the family. We love her to death, but she’s a walking stereotype of a millennial.

Well, sort of. She has no face tattoos or stretched earlobes, and I don’t believe she subsists on a diet of avocado toast and LaCroix.

But she’s just now finishing college – at the age of 26 – and is so wrapped up in social media, I’m nearly certain she would go through the cold sweats and seizures of withdrawal if you took her iPhone away.

This is nothing new. We’re used to it. But what I saw last week took even me by surprise.

Malu had an appointment to get her wisdom teeth removed, and my wife was busy at a kiddie birthday party. So, I volunteered to drive her to the dentist.

Midway through the surgery, I decided to peep through the window to make sure everything was under control. I didn’t understand at first what I was seeing. She was awake and had her arm outstretched with her iPhone in hand.

She was live streaming her dental surgery on Instagram.

There are so many questions here that begged to be asked.

Why would you broadcast that? Who would want to watch it? And why on earth didn’t the dentist crank up the nitrous oxide to knock her out and stop that nonsense?

We may never have answers to these questions.

But this incident does remind me of a relevant study I saw published last month.

TD Ameritrade commissioned a survey of 1,500 American millennials aged 21 to 37. More than half (53%) expected to be millionaires someday, and the median expected age at retirement was just 56.

Among the millennial men surveyed, the expected age of retirement was 53. TD Ameritrade didn’t specify whether males with their hair pulled back into manbuns qualified as “men.”

Oh, and it gets better.

The average age at which they expected to start saving was 36. So, apparently, they intend to hoard a lot of cash in a 17- to 20-year window in early middle age.

Good luck with that.

That particular stage of life also corresponds to your child rearing years, and every parent knows your expenses go through the roof when children come along.

So, unless you become an overnight YouTube millionaire (from streaming your wisdom tooth extraction, of course), reaching those financial goals is going to be a challenge.

It’s easy to poke fun at the unrealistic expectations of young(ish) people, though we’ve all been there.

I was in high school and college during the dot-com bubble years and fully expected to be a millionaire long before 30. That didn’t happen. (When I was 10, I also expected to be the started point guard for the Los Angeles Lakers, taking over for Magic Johnson once he retired. That, alas, also didn’t happen.)

Not all millennials are delusional. Fully 28% admitted that they don’t expect to retire at all.

Unfortunately, this is a lot more likely to be realistic.

A different study published earlier this year by the National Institute of Retirement Security found that 95% of millennials were not saving adequately for retirement and that 66% had not saved anything. And roughly half of the millennials with access to a 401(k) or similar plan at work don’t currently contribute to it.

It’s not completely their fault. Millennials really have had a rougher start in life than most of us due to the exploding cost of education, low starting salaries at the beginnings of their careers due to the lingering effects of the 2008 meltdown, and ridiculously expensive housing costs relative to incomes.

If you’re reading this, you’re probably not a millennial. We know the demographics our readers, and chances are good that you’re a baby boomer or a gen-Xer.

But it’s likely that you have millennial kids, grandkids or even younger siblings that are struggling to save and accumulate wealth. Here are a few things you can do to help:

  1. Encourage them – in fact, nag them incessantly – to stuff as much money as they can into their 401(k) plans. At a bare minimum, they should be contributing enough to get the full employer match (generally 3% to 5% of their pay). Ideally, they will get close to maxing out their contributions at $18,500.
  2. If you have the means to do so, incentive them to save by offering to match. For example, for every $5 they put into a savings account, you kick in an extra dollar. This is obviously more appropriate for teenagers or college kids than young adults with careers, but you get the idea.
  3. Teach them the importance of diversified income streams. Yes, the market “always” goes up over the long-term (or at least it has thus far). But if you really do want to retire at 56, you need to have the income to pay your bills.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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