Asset Value Illusion by David Merkel, CFA of alephblog

Are some Baby Boomers retiring because the current value of their assets is high?  This article from Bloomberg gives an ambivalent answer to the question.  Personally, I don’t know the answer to that question, but I can answer a related question: In the current market environment, where interest rates are low and stock valuations are high, should Baby Boomers accelerate their retirements?

The answer is no.  Here’s why: in retirement, you aren’t earning income from wages.  You need income to be able to pay for expenses.  If interest rates are low and stock valuations are high, you won’t be able to create much income relative to your assets.

It’s like owning a long bond that you intend to buy and hold for the income.  Do you care that interest rates have fallen, and the value of your bond is above where you bought it?  No.  It doesn’t give you any more income.  If you sold it, where would you reinvest to get more income at equivalent risk?

Let me digress: rather than looking at asset values, look at anticipated cash flow streams.  Have you grown you anticipated cash flow stream?  In a bull market, many look like geniuses, but if it is only due to a rise in valuations, it means that the cash flow streams are unchanged.

I realize this is a harder way to look at the markets, but for those that have managed the interest rate risk at life insurers, this is the way the best do it.  Have you created a higher income rate over the funding horizon?  That is true improvement of the economic position.

Don’t merely look at the current value of your assets.  That is an illusion of the true value in terms of income.  Think of it this way.  Say that you have surpassed your prior peak assets of 2007 recently in 2014.  Now look at the income you could have purchased in 2007 (use the long bond as a proxy — 5%), versus what you could buy today — 3.4%.  The ability to generate income is reduced by 30%+.

You might argue that the long bond is the wrong proxy — too long, too safe.  I would argue that the safety is necessary.  If you want to take more risks in fixed income, go ahead, but that is an option.  As for length, the length is close to what is needed, but if you used 20-year bonds, the argument would not change.

Final Notes

You might think you have a lot of money, but how much income can it generate?  Are you protected against inflation? Deflation? Credit risk?  Don’t assume because the asset balance is high that you are necessarily better off, because you might not be able to earn as much income off your assets.