In some ways, retirement planning is all about achieving the second of the following two outcomes:
- Running out of money before one runs out of time, or
- Running out of time before one runs out of money.
The time aspect of the equation deals with life expectancy. An adequate retirement plan may become wholly inadequate if one lives an extra ten years. On the other hand, a much more luxurious retirement could be experienced if one correctly anticipates a relatively short life span.
Thus, having a good grasp of life expectancy is a critical component of retirement planning. In answering this question, one can consider using some or all of the following tools:
SOcial Security Administration
The simplest of tools can be found on the website of the Social Security Administration. The Life Expectancy Calculator provides an estimate of the number of remaining years one can expect to live based on one’s gender and birth date. The estimate considers only the average results of a particular gender/age cohort. It does not contemplate one’s healthy or unhealthy lifestyle. It also ignores one’s genetics (e.g., did your mother and father die early?).
The Life Expectancy Calculator is a start but not a great answer. It gives a single point estimate when a range of values is probably more useful. For example, there is about a 50% chance one will live longer than the average life expectancy. If that happens, then one wants to know by how many years one will outlive the average. One extra year? Five? Twenty? The Life Expectancy Calculator does not answer these questions.
The Social Security Administration’s Actuarial Life Table may help. For example, according to the table a male of exactly 70 years has a 2.3528% chance of dying in the next year. This also means a 97.6472% chance of living for more than one year. A person with good math skills should be able to work out the probabilities of living to each age, up to the maximum of 119 on the table. Like the Life Expectancy Calculator, the Actuarial Life Table does not consider the unique circumstances of an individual (e.g., the life expectancy implications of genetics and lifestyle choices).
John Hancock offers its own Life Expectancy Calculator. This calculator may offer a more customized estimate of life expectancy because it accounts for a person’s unique circumstances, such as:
- blood pressure
- exercise habits
- alcohol consumption
- driving habits
We believe that the stock market generally does not make widely available any “free lunches.” From time to time low-risk, high-return opportunities may appear but they are rare. In that light, we wonder whether the tax advantages of REITs are impounded in, and offset by, higher valuations on REIT shares. This is an impossible-to-answer question, but one that is worth considering.
We start with the idea that – all things otherwise being equal – a higher stock price today means a lower expected long-term return in the future. Over a sufficiently long time horizon, a stock is worth the present value of all the dividends it is expected to pay in the future. If the present value of the expected dividends have not changed, then paying a higher price today simply reduces the expected rate of return.
In a highly competitive market for investment ideas, one should not expect that stocks with similar levels of expected risk should offer approximately the same levels of expected return. Assuming the same level of expected risk, if stock A is expected to offer a higher return than stock B, investors would be expected to buy stock A and to sell stock B.
Buying and selling causes stock prices to move. As we asserted earlier, over the long term, the higher a stock price today, the lower the expected future return. Contrariwise, the lower a stock price today, the higher the expected future return.
Thus, if the income tax code grants REITs a special tax advantage, we would expect the stock market to account for that advantage in the form of a higher stock price, which would have the effect of reducing the expected return of the REIT. Stock market participants should bid up the price (and reduce the expected future return) until the REIT has the same expected future return as a taxable company with the same risk.
Overconfidence is a well-established cognitive bias. Investors need to understand how overconfidence affects investment decision making. For the investor, overconfidence manifests itself in several different ways.
Overconfidence may lead investors to believe that their past investment returns exceed what they actually achieved. The obvious solution is to perform accurate return calculations. In practice, coming up with meaningful return calculations is much harder than one might think. When return calculations are either inaccurate or non-existent, the overconfident investor fills up the information vacuum with a rosy, distorted view of the past. Overconfidence may lead one to focus on the investments that did well while ignoring the poor performers.
Outside of investments, one can see such overconfidence in the public as a whole: the average American considers himself an above average automobile driver.
Overconfidence may also manifest itself in an unwarranted belief that one has a correct, accurate and truthful understanding of an investment opportunity. Sometimes, the more an investor “knows” about an investment, the more confident the investor becomes in his assessment of the investment’s prospects even if the “information” has little relevance. The investor’s confidence about his ownership of a company soars as he progresses from understanding value and momentum to memorizing its product line, visiting each of its field offices and interviewing sales trainees.
This form of overconfidence can also be seen in the paper industry analyst who gets promoted to portfolio management. Paper stocks are cyclical and not a significant share of the stock market. Therefore, a portfolio manager could ignore them most of the time: if he is wrong and they go up, they are unlikely to move the market so much that the portfolio’s returns will suffer (the same cannot be said for other sectors such as technology or health care). But the former-paper-analyst-turned-portfolio-manager will face constant temptation to own them because he “knows” the paper stocks so well.
One can protect against the dangers of knowing too much about an investment by deciding, in advance, what information best predicts future returns and ignoring all other information.