As Worth went
to press in early December, it appeared the
investment year would end on an up note. Indeed, by most measures, the economy
and the markets outperformed expectations across the board in 2005. The equity
markets found their footing in the fourth quarter, the dollar strengthened, GDP
grew at a respectable clip, energy prices eased and inflation seemed under
control. Granted, worries remained. The ballooning deficit, weakening credit
cycle and odd behavior of the bond markets, among others, could all cause
capital market catawampus. But, other than those who had committed too much
money to the underperforming hedge fund space, private investors could relax a
bit for the holidays.
 Then we come stomping along, publishing an article that seems
to be saying, "Hey, you’re probably spending too much money; think about cutting
back a bit." (See "Sustainable Spending".) No, we’re not actively
seeking to position Worth in the buzzkill section of the newsstand, nor do we covet the
role of the curmudgeonly contrarian. So before you roll your eyes and turn to
the article on collecting antique maps, bear with us another moment.
It turns out that an analysis of individuals’ long-term
spending patterns is a crucial, yet generally overlooked, factor in the wealth
management equation. Spending rates, even for very affluent individuals, play a
significant role in whether one’s wealth outpaces inflation or erodes sharply
over a lifetime. This may seem obvious: Those who spend a large portion of their
wealth every year will obviously run out of it. But, according to an analysis by
JPMorgan Private Bank, even those who spend only a small portion–as little as 5
percent–are headed for trouble.
JPMorgan is not uncharacteristically succumbing to some market
hysteria here; the group’s assumptions are quite conservative: a 2.25 percent
annual inflation rate and equity returns of 7 to 8 percent over the next 7 to 10
years. It concludes that a maximum 3 to 4 percent spending rate is optimal for
those whose goal is to stay wealthy.
Then we come stomping along, publishing an article that seems
to be saying, "Hey, you’re probably spending too much money; think about
cutting back a bit." |
Indeed, as John Ferry reports, careful analysis and management
of spending rates may be more important to achieving wealth preservation goals
than even asset allocation, which is the focus of enormous intellectual
resources in the investment management world. Making excellent asset allocation
decisions can mitigate, but not completely offset, the problems that arise from
overspending; similarly, if the equity markets return more than the 8 percent
JPMorgan assumes, it slows the rate of decline, but does not eliminate it.
This has obvious consequences for foundations, with their 5
percent minimum payout requirement. JPMorgan’s analysis suggests that these
institutions will be unable to preserve their asset bases indefinitely. Of
course, there is a vigorous ongoing debate over whether preserving that base is
an appropriate goal for a nonprofit. (See "The 5 Percent Problem," for
the case against it.) But those who wish to preserve their foundation’s spending
power ad infinitum face some difficult times ahead.
|
