Life Expectancies and Portfolio Risk

“Work as if you were to live a hundred years. Pray as if you were to die tomorrow.”
~ Benjamin Franklin

Leonardo Da Vinci’s life expectancy was 30 years when he was born in 1452. When my Grandma Branan was born in 1906, her life expectancy was 47. So in 454 years, life expectancy increased 17 years. That sounds pretty good—but wait, it gets better.

My youngest son was born in 1996, and his life expectancy is 77 years. Life expectancy increased 30 years in the 90 years between the birth of my grandmother and my son! This is astounding.

In the past, our clients laughed when we told them their financial plan assumed that they would live to age 100. Nobody laughs anymore. Almost all of us know someone well into their 90s or over age 100. We have a client who turned 100 last year. (So at least one of our financial plans was right!)

Why all the trivia about life expectancy? Retirees now need to live off their investments for 30 to 40 years; that’s as many years as they worked! To provide income for such a long period, retirees are forced to be in stocks. Their nest egg needs to grow to offset the long-term effects of inflation.

Let’s talk about inflation. Our retiree clients tell us that inflation hits them hard. Although the inflation rate has been relatively mild for the last 25 years, retirees know that inflation in food and medicine has been higher than the average inflation rate. Today I can buy a gallon of milk for $3.50, but 25 years ago a gallon of milk cost $1.60. A bottle of 100 Bayer Aspirin cost $1.38 in 1982, and today the same bottle costs $6.59.

One of the key components of BWFA’s financial plans is determining if your nest egg is properly allocated to give you an income stream to age 100. We are managing your portfolio to deflect your longevity risk (the risk that you will run out of money). This is not the same thing as chasing returns.

Meanwhile, portfolio risk is on everyone’s mind today. As the stock market has declined, many investors have fled the market. Bad move: These folks sold low.

Studies show that these same investors will reinvest in the market after it goes up. In other words, they will buy high. Over the period from 1986 to 2006, the S&P Index average annual rate of return was 11.7%. If you missed the 10 best days of those 20 years, you earned 8.6%, and if you missed the 30 best days, you earned 4.7%.

At BWFA, we have remained in the market, but in a way that protects your money. Foremost, we continue to seek transparency by investing in individual securities, so that we know what we are invested in. That’s a privilege you do not get with mutual funds, which make investment decisions and then tell you about them a few months later. We continue to invest in well-diversified portfolios consisting of solid companies, and we avoid speculative investments.

We have made adjustments. We have increased our cash position to its highest point in our history due to the uncertainty in the market. In a volatile market, we will be looking for good opportunities to put this cash to work. In addition, we have moved toward defensive stocks that favor this market.

In summary, we remain in the market because you need to be there for the long term. We continue to manage risk by adjusting portfolios to take advantage of what is happening in the market. We help keep your eyes focused on the long term so you can enjoy your ripe old age.


The Rule of 70
Have you ever wondered how quickly inflation’s impact will make a large difference in prices? Here’s a quick approximation that tells you how rapidly a rate of inflation can double your costs: Simply divide 70 by the rate of inflation, and that’s how long it will take for prices to double. For example, 70 divided by 3.5, tells you that at 3.5% inflation, prices will double in approximately 20 years. Keep in mind that for the 12 months ending on January 30, 2008, the Consumer Price Index increased by 4.3%.