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Monday, December 20, 2010

Buying your last new car

Mike Smitka
Retirees have been good car customers the past decade, particularly those who retired in 2005-2007. Will the next decade will be a different story? -- initial data suggests "yes." And it won't be a good one.
A recent working paper[1] by Wade D. Pfau at the National Graduate Institute of Policy Studies in Tokyo argues that data show the likely financial status of retirees in 2000 -- not a bad year -- will be worse than for any group since 1926. The basic issue is that returns on investments are low; the "rule of thumbs" for how much you needed to save and the rate at which you could draw down savings are proving optimistic.
Pfau examines the long-accepted 4% rule of thumb for an equity investments: that it's safe to draw down that much of principle. But he finds that US returns during 1926-1980 were higher than they have been during the past 30 years. Furthermore, they were higher than in a wider sample that includes 17 other developed countries and a longer time period; in many cases, a 3% rule of thumb was too optimistic. The past is no guide to the future, but will we see a return of historic dividend levels and capital appreciation anytime soon? Never mind bond performance -- with near-zero interest rates, that's no help for the average investor.
Part of what happens is that down years accentuate the depletion of assets, and down years early on do the greatest damage. That is, those who retired in 1999 and 2000 had to liquidate a larger than anticipated share of their holdings in the bad years of 2001 and 2002. Even though asset prices recovered for the next 5 or so years, that didn't help because they'd sold off so much of their portfolio. Those who retired early were the most vulnerable, in what Pfau notes the finance literature calls "reverse dollar cost averaging."
So what of recent retirees, many of whom saw their paper wealth and chose to stop working at comparatively young ages? I fear the worst. Recent losses on assets make "downsizing" housing, the biggest component of wealth, problematic. The bond component of portfolios is earning almost nothing (though if an individual was prescient and held only "long" bonds they'd have a nice capital gain -- but if they saw the future that clearly, they are probably still working...). The initial hit to stock portfolios was huge, and many invested aggressively. Of course inflation is low -- unless you have a less-than-golden healthcare policy. Or have an old home that isn't well insulated, and, since you're home all the time, you keep constantly warm.
The logic and data of Pfau's article is thus quite unsettling, even if (as he notes more than once) the past is not a good guide to the future. His references though don't suggest that the future will be rosy: John Bogle's Enough: True Measures of Money, Business and Life, John Wiley, 2009; Dimson, Marsh and Staunton "Irrational Optimism" from the Financial Analysts Journal 60:1, 2004; and John West, "Hope is Not A Strategy," Fundamental Index Newsletter, October 2010.
Of course we could be on the threshold of an era of strong growth. But my position as an expert on the Japanese economy is clear: their "lost decade" and what the US is looking at are analytically similar (though our growing population should shorten the period of stagnation).
For the auto industry, that means that a higher than normal share of the baby boomers have already bought their last new car.
[1] See Will 2000-era retirees experience the worst retirement outcomes in U.S. history? A progress report after 10 years by Wade D. Pfau.
Note that I have not looked for data on new car purchases by retirees; my small sample of relatives and neighbors may be sorely misleading. If you have such data, please let me know!!