Investors are shrugging off the suggestion that stocks are over-valued or that the technology innovators are a one-way path to riches if the year-to-date performance of Tesla Motors (TSLA) and Facebook (FB) are any indication. Twitter’s stock (TWTR), which soared from a $45 closing price on its first day of trading (November 7, 2013) to a high of $73.30 on December 26, has fallen 32% since the start of 2014. Twitter is now trading at slightly below $45. Given the excitement surrounding the Twitter IPO less than six months ago, what does this apparent reversal of (expected) fortunes suggest? It is certainly too soon to conclude that a business model that made sense at the IPO has proven to be faulty. Does Twitter’s dramatic decline signal a shift in investors’ willingness to bet heavily on a future earnings stream that is almost impossible to predict? Continue reading
The question of whether to buy or rent a home is of enormous economic significance for most families. Home equity represents the vast majority of American families’ net worth (see chart below). In a post in mid-2011, I discussed some of the major economic variables in the decision to buy a home. My conclusion was that buying a home made sense, but not because housing generates attractive long-term investment gains. The long-term data suggests houses have historically increased in value at a rate only slightly higher than inflation. The best arguments for owning a home, I argued, were historically-low interest rates, the mortgage interest tax deduction, and the inflation hedge provided by locking in your costs for shelter for the long-term. Since that time, housing prices and rents have risen dramatically. In the past week I read two thoughtful and interesting articles on the economics of owning a home that motivated me to revisit this topic for 2014.
In the financial advisory business, one of the most pressing and controversial topics is how much money people need to save during their working years in order to provide for long-term retirement income. The research on this topic has evolved quite a lot in recent years, and a recent issue of Money magazine features a series of articles representing the current view on this critical topic. These articles, based around interviews with a number of the current thought leaders on this topic, deserve to be widely read and discussed.
The series of articles in Money kicks off with perspectives by Wade Pfau. Pfau’s introductory piece suggests a difficult future for American workers. A traditional rule-of-thumb in retirement planning is called the 4% rule. This rule states that a retiree can plan to draw annual income equal to 4% of the value of her portfolio in the first year of retirement and increase this amount each year to keep up with inflation. Someone who retires with a $1 Million portfolio could draw $40,000 in income in the first year of retirement and then increase that by 2.5%-3% per year, and have a high level of confidence that the portfolio will last thirty years. It is assumed that the portfolio is invested in 60%-70% stocks and 30%-40% bonds. The 4% rule was originally derived based on the long-term historical returns and risks for stocks and bonds. The problem that Pfau has noted, however, is that both stocks and bonds are fairly expensive today relative to their values over the period of time used to calculate the 4% rule. For bonds, this means that yields are well below their historical averages and historical yields are a good predictor of the future return from bonds. The expected return from stocks is partly determined by the average price-to-earnings (P/E) ratio, and the P/E for stocks is currently well-above the long-term historical average. High P/E tends to predict lower future returns for stocks, and vice versa. For a detailed discussion of these relationships, see this paper. In light of current prices of stocks and bonds, Pfau concludes that the 4% rule is far too optimistic and proposes that investors plan for something closer to a 3% draw rate from their portfolios in retirement. I also explored this topic in an article last year.