Our society and financial industry is riddled with conventional definitions in financial terminology that are misunderstood. After nearly 30 years of financial advising experience, I take a bit of a countercultural view.
Here are just a few …
Conventional: Income from Investments. I have found that folks use the term “Income” as a measure of their spending power. “Income” is defined conventionally as interest earned on bonds or CDs and dividends paid from equities. (Another way of saying this would be, “Don’t touch principal and live off the interest.”)
Perhaps this poor definition of income is rooted in history. If we study the period from 1871 - 1957 you will find a very interesting relationship between equities and the 10-year US treasury. 1) The yield on equities was always greater than the yield on the 10-year US treasury. 2) The average dividend yield from equities was 5.34% vs the 10 year US treasury at 3.51%. 3) Price appreciation from equities was a lesser part of the total return. During this period, it seems probable that the yield on your equity investment was the primary determination for expected future return. Then again, if we study the period from 1958 - 2007 we find a completely different set of events. 1) The average yield on the 10 year US Treasury averaged 6.72% vs. 3.15% for the S&P 500. 2) The yield on fixed income was now higher than equities in excess of 3% a year. 3) Price appreciation from equities became a greater part of the total return.
1 2 Re-defined: Withdrawals from Investments. However this saying came into our vernacular, it is poor advice. Focusing on yield can lead to making investments in extremely volatile asset classes. Generally speaking, the higher the yield compared to current standards, the higher the volatility. Some high yielding investments even include the use of margin, which can cause multiples of volatility and even an annihilation of the investment altogether.
With a portfolio fully invested in the 10-year US treasury, an investor certainly would have received interest payments on time and their principal returned at maturity. However, generally their purchasing power of that matured principal is now worth multiples less than the original investment because of inflation. Since 1982, Inflation has been moderate, averaging 2.78% per year.
3 Mathematically, the proceeds from an original investment with a 10-year maturity, after accounting for 2.78% inflation, has 25% less purchasing power.₃ Losing purchasing power counts as a loss in my book.
Equities, on the other hand, have provided a rising level of income over time that has outpaced inflation. The catch is that it might be difficult to only live on the dividends since yields are low relative to historical standards. Today, the yield on the S&P 500 is about 1.37%.
2 For almost 100 years, large companies in the USA have averaged a total return of about 10%.
4 The key words are “total return” - which is dividends + appreciation. It is my opinion, that the conventional definition of “Income” does not leave room for the awareness of appreciation. My suggestion is to position the spending allocation as “Withdrawals” instead of “Income”.
Conventional: Full Retirement Age for Social Security is age 66 - 67 - Begin your social security when Full Retirement Age is attained.
Social Security was founded in 1935. The age of qualification for payment was 65 and designated as Full Retirement Age. The Social Security Amendments of 1956 introduced early benefits at age 62 for women only. Benefits received prior to age 65 were reduced to take account of the longer period over which they would be received. The 1961 amendments extended eligibility for reduced benefits to include men. A provision allowing for a 1% credit a year for delaying retirement past age 65, up to age 72, was first enacted as part of the 1972 Amendments. It was increased to 3% a year in the 1977 Amendments. In 1983, Congress passed a law to gradually raise the Full Retirement Age because people are living longer and are generally healthier in older age. The Full Retirement Age gradually increases by a few months for every birth year, until it reaches 67 for people born in 1960 and later. The 1983 Amendments lowered the age at which the increase no longer applied to 70 (to correspond to the age of 70 at which the earnings test no longer applies). The 1983 Amendments also phased in an additional increase from the 1977 Amendments for delaying past “Full Retirement Age”. An extra 2/3 of 1% for each month you delay after your birthday month, adding up to 8% for each full
year you wait until age 70.
5 6 7Re-defined: Minimum Retirement Age is 62, Standard Retirement Age for Social Security is 66 -67, & Maximum Retirement Age is 70. I believe the term “Full Retirement Age” is misleading and outdated. Merriam-Webster defines “full” - as containing as much or as many as is possible or normal. Definition 3(a) of “full” actually uses the term “maximum”: being at the highest or greatest degree.
₈ Anyone that begins to collect Social Security at an age younger than 70 is not earning their maximum. The 1983 Amendment changed this. Maximum Retirement Age is 70. The 8% per year of guaranteed growth is the very reason why “Full Retirement Age” at age 65 is not “Full”. I propose we swap out “Full” with calling age 62 and 70 for what they are: the minimum & maximum. Perhaps more folks would choose to defer until age 70, if we deleted “Full” and replaced it with “Standard” Retirement Age.
Conventional: Crash, Plunge, Collapse, Bubble, Mania, Crisis, Panic: Most descriptions of a decline in equity prices. We are in a headline culture. Whether it is from an organization or an individual, the more dramatic a statement, the more attention our culture gives. Here are the technical definitions of a decline in equity prices. 5% is a Pullback, 10% is a Correction, 20% is a Bear Market.
9 Since 1951, the S&P 500 index has experienced on average, 5% declines 3 times a year, 10% declines about once a year, and 20% declines about every 5 years.
10Re-defined: Temporary Decline. This one is a bit tricky. While we are in the midst of a decline, I assure you it FEELS like the conventional definition. Make no mistake - Money is emotional. Our society will pander to these scared FEELINGS and use dramatic terminology to describe the activity. Since we are human, I believe it is OK to have these FEELINGS. However, during times of distress, it is of utmost importance to be acting on the plan, not re-acting to our FEELINGS.
As of this writing, equity prices, as a group, have recovered from every decline the markets have ever experienced. I believe that this trend will continue. However, the key words are “as a group”. It is worth pointing out that ownership in any one company can go bankrupt which can turn that investment into nothing. Leverage, margin, or lines of credit can also wipe out a portfolio during a decline. Lastly, folks without a plan or a plan that is not prepared for declines can also suffer life-altering outcomes.
"We've always done it this way" thinking needs to be challenged from time to time. When investment plans are formulated, having a counterculture perspective can be deeply beneficial to the owners of that plan.
- Securities-based lending has special risks and is not appropriate for everyone. If the market value of a client’s pledged securities declines below required levels, the client may be required to pay down his or her line of credit or pledge additional eligible securities in order to maintain it, or the lender may require the sale of some or all of the client’s pledged securities. Wells Fargo Advisors will attempt to notify clients of maintenance calls but is not required to do so. Clients are not entitled to choose which securities in their accounts are sold. The sale of their pledged securities may cause clients to suffer adverse tax consequences. Clients should discuss the tax implications of pledging securities as collateral with their tax advisors. An increase in interest rates will affect the overall cost of borrowing. All securities and accounts are subject to eligibility requirements. Clients should read all lines of credit documents carefully. The proceeds from securities-based lines of credit may not be used to purchase additional securities, pay down margin, or for insurance products offered by Wells Fargo affiliates. Securities held in a retirement account cannot be used as collateral to obtain a loan. Securities purchased in the pledge account must meet collateral eligibility requirements.
- Wells Fargo Advisors is not a legal or tax advisor.
- This information is made available with the understanding that Wells Fargo Advisors and its affiliates are not engaged in rendering legal, accounting or tax advice.
- Dividends are not guaranteed and are subject to change or elimination.
- Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can cause a bond’s price to fall. Credit risk is the risk that an issuer will default on payments of interest and/or principal. This risk is heightened in lower rated bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
₁ https://www.multpl.com/10-year-treasury-rate/table/by-year
₂ https://www.multpl.com/s-p-500-dividend-yield/table/by-year
₃ https://www.multpl.com/cpi/table/by-year
₄ https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp#citation-5
₅ https://www.ssa.gov/history/50mm2.html
₆ https://www.ssa.gov/history/briefhistory3.html
₇ https://www.ssa.gov/pressoffice/DlyRetCrdtFactSheet.html
₈ https://www.merriam-webster.com/dictionary/full#:~:text=in%20the%20face-,full,extent%20enjoy%20to%20the%20full
₉ https://www.cmegroup.com/openmarkets/finance/2020/16057-a-pullback-correction-or-bear-market-how-totell-the-difference.html
₁₀ https://www.capitalgroup.com/individual/planning/market-fluctuations/past-market-declines.html