Estimating "present value net worth"

[Rustic23]

If your point of view is that inflation should not be considered in the discount rate, we will just have to agree not to agree. My guess is we are not communicating our point of view and it is not worth the time and effort to continue this further.

 

[Maurice]

Well, market interest rates presumably take inflation expectations into account, so maybe our disagreement is mere semantics.

 

[clifp]

As Barbie says "Math is hard"

My new plan is to spend it all,when I run out. Go out like David Caraddine in a state of bliss.

 

[Gone4Good]

If your point of view is that inflation should not be considered in the discount rate

The way I understand it, his point of view (and mine too) is that the inflation assumption is already embedded in the nominal discount rate. As in . . . "Real Rate" + Inflation = Nominal Rate . . . or . . . TIPS rate + Inflation = Treasury Rate

So if you use the treasury rate to discount a nominal future cash flow, you are already using an inflation assumption that is determined by an efficient market. So there is no need for you to make any assumptions about inflation whatsoever.

 

[Rustic23]

yrs to go,
I agree completely, and figured semantics was at the heart of our discussion. An example I would use is the cost of money, historically, is a percent to a percent and a half. (I don't have any proof of that just a quotes from several professors) Likewise the long term inflation rate in the U.S. is about 3.5%, again not source. Add the two together and you get 5%, or close. This represent a 'safe rate' if 'inflation' is expected to be 'normal'. However, few expect the inflation rate to be that low over the coming years, yet the current treasury rates, (and I have not looked recently) I believe would lead one to believe that higher than normal inflation is not currently priced into the 'safe' discount rate.

My point in trying to bring out the components of a discount rate, is that each of us have our idea of what inflation, and risk might be in our future income flows. Also to point out the ease of which excel makes calculating discount cash flows. As risk can effect the discount rate more than inflation and cost of capital, it is the determination of risk that separate good appraisers from hacks. And, it is the ability to assess risk in ones own portfolio that will make the biggest difference in ones net worth.

 

[Meadbh]

Couple of questions for Nords:
1. Does the US government fund its military pensions (a) as a going concern, or is it held to the more stringent actuarial standard of (b) possible "dissolution"?
2. Where is the pension fund invested? (a) Gummint bonds (owned by millions of Chinese people)? (b) Equities and other market instruments?
3. If 1(b) and 2 (a) or (b) is true, does Nords' risk tolerance change at all?

 

[Maurice]

yrs to go,
I agree completely, and figured semantics was at the heart of our discussion. An example I would use is the cost of money, historically, is a percent to a percent and a half. (I don't have any proof of that just a quotes from several professors) Likewise the long term inflation rate in the U.S. is about 3.5%, again not source. Add the two together and you get 5%, or close. This represent a 'safe rate' if 'inflation' is expected to be 'normal'. However, few expect the inflation rate to be that low over the coming years, yet the current treasury rates, (and I have not looked recently) I believe would lead one to believe that higher than normal inflation is not currently priced into the 'safe' discount rate.

My point in trying to bring out the components of a discount rate, is that each of us have our idea of what inflation, and risk might be in our future income flows. Also to point out the ease of which excel makes calculating discount cash flows. As risk can effect the discount rate more than inflation and cost of capital, it is the determination of risk that separate good appraisers from hacks. And, it is the ability to assess risk in ones own portfolio that will make the biggest difference in ones net worth.

I think you're conflating this with project finance. When valuing fixed income products you don't need to develop a view of risk. The market gives it to you. And 'cost of capital' is irrelevant. And there's no need to develop a view on inflation, you just discount using the risk-free interest rate.

Anyway, I'm beating a dead horse here.

 

[Maurice]

In one sense this problem is trivially simple - we're talking about how Nords should value cash flows from the government.


To value your IBM stock, all you need to know is the current price of IBM stock.

To value cash flows from the government, all you need to know is the current price of cash flows from the government. That's what interest rates are.

 

[jdw_fire]

Couple of questions for Nords:
1. Does the US government fund its military pensions (a) as a going concern, or is it held to the more stringent actuarial standard of (b) possible "dissolution"?
2. Where is the pension fund invested? (a) Gummint bonds (owned by millions of Chinese people)? (b) Equities and other market instruments?
3. If 1(b) and 2 (a) or (b) is true, does Nords' risk tolerance change at all?

i believe 1 is (a) but if it was like federal civilian pensions/SS, the "Gummint bonds" it would be invested in would be owned by the fund not the "Chinese people"

 

[Gone4Good]

However, few expect the inflation rate to be that low over the coming years, yet the current treasury rates, (and I have not looked recently) I believe would lead one to believe that higher than normal inflation is not currently priced into the 'safe' discount rate.

My point in trying to bring out the components of a discount rate, is that each of us have our idea of what inflation, and risk might be in our future income flows.

Fair enough.

But your approach yields a result that reflects your personal opinion about what the present value is. Using the market rate yields a market value.

 

[Nords]

Couple of questions for Nords:
1. Does the US government fund its military pensions (a) as a going concern, or is it held to the more stringent actuarial standard of (b) possible "dissolution"?
2. Where is the pension fund invested? (a) Gummint bonds (owned by millions of Chinese people)? (b) Equities and other market instruments?
3. If 1(b) and 2 (a) or (b) is true, does Nords' risk tolerance change at all?

Those are darn good questions, which I probably should have learned the answers to at least seven years ago. However the most common response has been either "If this pension isn't paid then you'll have too many other things to worry about" or "That's why Congress has the power to tax and we have the power to vote."

I think DoD puts the pension numbers in the annual funding requests, but I don't know if there's a "lockbox" or other investment trust. I can remember lots of funding-brinkmanship fuss at the end of the fiscal year about whether active duty military would be paid if Congress didn't pass the legislation, but I've never heard any of that regarding retirees.

Here's an excerpt from the FY08 "Statistical Report on the Military Retirement System". Maybe the vocabulary is used in a comptroller or funding sense. Or maybe the amounts quoted below just aren't considered a big enough sum to be of any concern.

The military retirement system applies to members of the Army, Navy, Marine Corps, and Air Force. However, most of the provisions also apply to retirement systems for members of the Coast Guard (administered by the Department of Homeland Security), officers of the Public Health Service (administered by the Department of Health and Human Services), and officers of the National Oceanic and Atmospheric Administration (administered by the Department of Commerce).

The system is a funded, noncontributory defined benefit plan that includes non-disability retired pay, disability retired pay, retired pay for reserve service, survivor annuity programs, and special compensation programs for certain disabled retirees. The Service Secretaries may approve immediate non-disability retired pay at any age with credit of at least 20 years of active duty service. Reserve retirees generally must be at least 60 years old and have at least 20 qualified years of service before retired pay commences; in some cases the age can be less than 60 if the reservist performed certain types of active service. There is no vesting before retirement.

Here's the financial obligation (I've edited the text to summarize it):

As of September 30, 2008, there were:
-- 1.47 million non-disability retirees from active duty receiving $36.9 billion retired pay.
-- 86,000 disability retirees receiving $1.29 billion.
-- 329,000 reserve retirees receiving $4.2 billion.
-- 291,000 survivors of military members receiving $3.27 billion.

Less than $46B/year.

And here's how the COLA is calculated:

The “full” COLA effective December 1 is computed by calculating the percentage increase in the average CPI over the third quarter of the prior calendar year to the third quarter of the current calendar year. The increase is based on the Urban Wage Earner and Clerical Worker Consumer Price Index (CPI-W) and is rounded to the nearest tenth of one percent.

The answer to the third question is that it doesn't change our risk tolerance. The legs of our ER stool include two separate military pensions, a rental property, Social Security, and an investment portfolio. We don't mind having our investment portfolio 92% in equities (with 8%/two years' expenses in cash), and we've leveraged some of that with mortgage debt. If our portfolio gets 30-50% bigger during a recovery then "taking some off the table" would probably result in raising the cash percentage (I bonds?) or paying down the mortgage. But if the Dow went down to 6000 then we might become stock buyers again. We don't carry any investments on margin, and we don't trade options. I've also stopped shorting equities. So I guess we're as volatile as we want to be.

I'll see if I can find the answers to those first two questions. Do we have any veterans here with DoD staff or legislative experience on the military funding process?

 

[W2R]

Nords, I gather from this GAO document that military retirement is held in a government trust fund (like Social Security).

 

[Maurice]

Someone once said that the government saving money in treasury bonds is like American Airlines banking Advantage miles.

I don't entirely agree, but its a good line nevertheless.

 

[Texas Proud]

Nords, I gather from this GAO document that military retirement is held in a government trust fund (like Social Security).

The answer is..... there is no 'real' investments for any of the trust funds out there... they are all accounting entries... I will give an example... but I did not do any research to see if this is really the way it is... but this is how the federal gvmt works with other funds...

Say that the amount that is determined to fund the trust fund is $100 billion... then there is an entry in the general fund to move that $100 billion from the general fund to the trust fund... DONE... funded... the trust fund now has an investment of the US gvmt showing it is owed money...

Now, at some time they need to send out checks to our retired military folks such as Nords... they cash in the amount that is needed, cut checks (or direct deposit) and pay everybody....

Remember, the gvmt can print the money at any time.... it is not like the various state funds who actually own stocks, bonds, real estate etc... something that is 'funded'...

So, like SS, it seems it is just a promise to pay and an accounting entry... No lockbox, no investments, no......

 

[Maurice]

That's misleading, Texas Proud. The debt would have been issued anyway. If the SSA didn't buy them someone else would have to. And the securities are real and are marketable.

(I'm talking about the SSA, not military pensions)

 

[Rustic23]

I did not read all of this, but from what I can tell, that although called the 'Military Retirement Trust Fund' it is a pay as you go system. It might take one of the accountants looking at the statement at the end, but it appears there are no assets in the fund, other that those to pay current year liabilities.

http://www.pentagon.mil/comptroller/***/fy1998/50_MRTFCFO98.pdf

 

[Texas Proud]

That's misleading, Texas Proud. The debt would have been issued anyway. If the SSA didn't buy them someone else would have to. And the securities are real and are marketable.

(I'm talking about the SSA, not military pensions)

Yes.... SS is different in that they have their own tax money coming in... and it is more than goes out... so they ARE buying debt of the gvmt... and then the gvmt spends that money....

The military pension does not have a separate tax... (well, maybe someone in the military can tell me if they take something out of your check that says military retirement)... so it is an accounting entry...

 

[Texas Proud]

I did not read all of this, but from what I can tell, that although called the 'Military Retirement Trust Fund' it is a pay as you go system. It might take one of the accountants looking at the statement at the end, but it appears there are no assets in the fund, other that those to pay current year liabilities.

http://www.pentagon.mil/comptroller/***/fy1998/50_MRTFCFO98.pdf

Is there one newer than 1998

If you look at footnote 13... it says the present value of benefits that are payable is $644 billion... and at the time they had $147 billion in investments... so underfunded at the time...

They only paid out $31 billion...


Wow... went down further and it is all on one page for the assets etc..... pg 33... table 1

 

[Maurice]

Yes.... SS is different in that they have their own tax money coming in... and it is more than goes out... so they ARE buying debt of the gvmt... and then the gvmt spends that money....

The military pension does not have a separate tax... (well, maybe someone in the military can tell me if they take something out of your check that says military retirement)... so it is an accounting entry...

Agreed.

 

[Rustic23]

Here is the 2004 report. Not much change in assets, and still a large unfunded amount.

 

[Finance Dave]

I'm still looking for other annuity website calculators where we can get numbers without having to provide contact info. Post your links to this thread.

I use formulas and you can code them into Excel if you like. I'm not a frequent reader, so if you're interested PM me. I have them written down at work and could get them if anyone is interested. There are several different ones depending on whether the amount contributed/analyzed is constant each year or it increases at some rate.

 

[Nords]

The military pension does not have a separate tax... (well, maybe someone in the military can tell me if they take something out of your check that says military retirement)

No, military aren't forced to contribute toward their retirement.

TSP contributions are still voluntary, although I could see a day when recruits would be automatically signed up for a 10-15% contribution and then have to submit a request up the chain of command to reduce it.