CONVERS-{GN OF FARM ASSETS FOR EE’FEREMEK? PUE’EGSES Thesis 5m- {ém Dogma :5? 553. D‘ lfiCHiS 1‘3 STEVE Ufii‘éfmfif‘i' YER/away; Ferd; Lee E9339 LIBRARY llflllilllvflzllfltljlllllllljllllllLLHflllllzllli3llll7llflll ,M " University —.‘ w-O—O I This is to certify that the thesis entitled CONVERSION OF FARM ASSETS FOR RETIREMENT PURPOSES presented by Warren Ford Lee has been accepted towards fulfillment of the requirements for M degree inJgrinnltural Economics 1/ Major professor Date ‘ 5;...54/ 7 d / 0-169 vgw ___~i Cfi'nvnvq Vf‘ ‘ pfllZuWU$Vl The business org United State firm is clos Operator, an disinvestmen are VOhmtar 0'13 9-59 and eventually m ABSTRACT CONVERSION OF FARM ASSETS FOR RETIREMENT PURPOSES By Warren Ford Lee The single proprietorship is the predominant form of business organization for agricultural production in the United States. The growth cycle of the single proprietorship firm is closely related to the life cycle of the owner- Operator. and generally the business terminates with the disinvestment stage when his labor, management and capital are voluntarily or involuntarily withdrawn from the business. Old age and the accompanying decline in physical health eventually make it impractical for elderly people to continue active farming. The basic financial problem confronting the retiring farmer is to convert farm assets to sources of retirement income with a minimum of capital loss. The closely related personal problem of disinvestment is to achieve a retirement situation which is consistent with his personal goals. The objectives of this study were to describe the financial and personal characteristics of retirement age farmers and to recommend disinvestment strategies which would fulfill their financial and personal goals. A small random sample of farmers and retired farmers age 60 and over was interviewed during July and August of 1969 to obtain information on their financial positions and retirement 5 rand affect indicated the arrangements Tent income d Usually retii estate asseti several year! receiving ve: Lsets, yet, Sewrities s Ticriinancial reluctance t TeaChlng 1‘81 The analyzed We} and (2) met; Warren Ford Lee retirement goals and to determine the constraints which would affect their retirement programs. The survey results indicated that most elderly farmers have not made adequate arrangements for converting their assets to sources of retire- ment income or for transferring their estates to their heirs. Usually retirement is a gradual process in which nonreal estate assets are allowed to depreciate out over a period of several years. As a group. the survey respondents were receiving very low income returns from their productive assets, yet they eXpressed a negative attitude toward nonfarm securities such as common stocks, bonds, and mutual funds. Nonfinancial retirement goals apparently account for their reluctance to completely liquidate their farm assets upon reaching retirement age. The two basic retirement alternatives which were analyzed were: (1) complete liquidation of the farm business and (2) retaining the farmland and renting it out. These alternatives were analyzed on the basis of financial and personal retirement goals. capital losses. and estimated amounts of real annual income. Life expectancy probability data were used to insure a high probability that the estimated annual income would be maintained for a sufficient period of time. A comparative analysis of eight investment alter- natives indicated that during periods of economic prOSperity, both farm and nonfarm equities would be superior to fixed income securities such as bonds. land contracts and mrtéa-Ses' i the highest 1 depression. securities WE were the rett ically have 1 retiring fart Liqui raging from Value of pro Feters who 1 item capital aiiitional e: be aecuratel; Stock Prices a. mem “0 tOlei ”he illic- Liven Warren Ford Lee mortgages. The fixed income securities would have yielded the highest returns during a hypothetical period of economic depression. The total annual returns to nonfarm equity securities were slightly higher but much more variable than were the returns to farm real estate. Nonfarm equities histor- ically have provided higher and more stable income returns than farm real estate. Nonfarm equity and fixed income securities are superior to farm real estate, land contracts, farm mortgages, and annuities on the basis of liquidity. but farm real estate is much easier to manage for the typical retiring farmer. Liquidation of farm assets results in capital losses ranging from about 11 percent to nearly ho percent of the value of productive assets owned prior to liquidation. Farmers who retain their farm assets during retirement also incur capital losses in the form of depreciation and possibly additional estate transfer costs, but these losses could not be accurately estimated. Given a combination of depressed stock prices and historically high bond yields. the expected rates of return on nonfarm securities would be high enough to compensate for normal amounts of capital losses. Either of the two retirement alternatives would be suitable for most medium and high net worth situations. Their comparatively strong financial position would permit them to tolerate the risks associated with nonfarm securities or the illiquidity and lack of flexibility associated with an investment in farm real estate. The liquidation alternative with a low cc suitable for compromise be could be ach: farm is sold. capital loss« izpcrtant pei Warren Ford Lee with a low cost form of retirement housing would be more suitable for most low net worth situations. A reasonable compromise between the liquidation and rental alternatives could be achieved by retaining the farm dwelling when the farm is sold. This compromise alternative would minimize capital losses in addition to fulfilling most of the more important personal retirement goals. .. ”‘9 a in p; A‘VVIQI‘“ . ‘ _~ CVel'wtu. CONVERSION OF FARM ASSETS FOR RETIREMENT PURPOSES By Warren Ford Lee A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Agricultural Economics 1970 2‘. Q d to which 17 uqlfi my“. no t. AV and fa: ACKNOWLEDGMENTS The author wishes to express his sincere appreciation to Dr. J.R. Brake for the valuable guidance and counselling which he provided throughout the graduate program. The author also wishes to thank Dr. D.L. Armstrong. Dr. R.E. Hepp, Dr. L.V. Manderschied and Gerald Schwab for their assistance with the thesis project. The financial support furnished by the Department of Agricultural Economics. Michigan State University and The Canada Council is gratefully acknowledged. A special thanks is extended to the author's wife and family for their encouragement and for the many hours which Barbara cheerfully devoted to typing the thesis. ii 7., [aw LIST OF CA3 1:3: or W A... p In“; ‘Cw tier k. .olafl'v '7'» Q‘.‘. S'.P~'fi‘ b ‘ .- h l TABLE OF CONTENTS LIST OF TABLE 0 O O O O O O O O O O O O O O 0 LIST OF FIGURES O O O O O O O O O O O O O O O 0 Chapter I. INTRODUCTION 0 I O O O O O O O O O O O O O The PrOblem Area 0 o o o o o o o o o o ObjeCtiVeS Of the StUdy o c o o o o o 0 Description of the Disinvestment Stage Importance of the Study . . . . Other Related Research . . . . Outline of the Study . . . . . O O O O O O O O O O 0 II. INVESTMENT STRATEGIES FOR RETIRING FARMERS The Concept of a Risk-Returns Utility FunCtion c o o o c o o o o o o o o o 0 Defining and Measuring Risk . . . . . . Defining and Measuring Returns . . . . Desirable Investment Characteristics . An Analysis of Eight Investment Alterna Summary 0 o o o o o o o o o o o o o o 0 III C SURVEY PROCEDURE 0 O O O O O O O O O O O 0 Definition of the Population . . . . Sampling Procedure . . . . . . . . . Questionnaire DBSign o o o o o o o 0 An Evaluation of the Survey Procedure Suggestions for Future Surveys . . . Summary 0 o o o o o o o c o o o o o 0 IV. DESCRIPTIVE ANALYSIS OF THE DISINVESTMENT PRO BLEB'I ~ 0 t C O O O O C O O O O O O C O O O Biographic Information . . . . . Retirement Goals . . . . . . . . Financial Situations . . . . . . iii ti V38. 66 66 73 79 Chapter T. 1.". Re V. A'IAIY #" (ll U1 D-I (I) (n 0:1 mm Su: Chapter Attitudes Toward Investment Alternatives A Comparison of Retired ReSpondents with Those Still Farming o o o o o o o o o o 0 Retirement Age Farm People in PerSpective V. ANALYZING RETIREMENT DECISIONS . Estimating Capital Losses . . . . . . . . Estimating Rates of Return on Investment Altematives o o o o 0 Determining the Rate at Which Cap ital Stock carlBeLiQUidatedocoooooooooooc summaryoooooooo VI. CASE STUDY ANALYSIS . . 0 Selection of Cases for Portfolio Analysis Assumed Rates of Return for Early Low Net Worth Case . . Medium Net Worth Case . High Net Worth Case . . Summary . . . . . . . . VII. SUMMARY AND CONCLUSIONS . The Problem Area 0 o 0 Summary of the Survey Resul 3 Recommendations . . . . Implications of the Study . . Suggestions for Further Resear h BIBLIOGRAPHY O O O O O O O O O 0 APPENDIX 0 O O O O O O O 0 O O 0 iv o o o o C 1970 98 101 106 109 109 124 127 130 131 132 13% lhh 149 156 160 160 161 l6u 173 177 179 l83 1'1. 1'20 1 t e §“l O “A“ u UVU LIST OF TABLES Table Page I-l. Economic Class Comparison of Under Age 65 and Age 65 and Over Farm Operators, 196#. 5 I-2. Income of Farm Operators from Nonfarm Sources, 196“ e o o e e e e o e e e o e o 7 I-3. Estimated Average Household Income by sour0689196l4’eeoeoeeeeeeeee 8 I-h. Percentage of Farms Having Convenience ASSBtSeeeoeeeeooeeooeoe 9 I-5. Comparative Income Estimates for Farm and Nonfarm HousehOldS e e e e o o e e o o e 10 II-l. Life EXpectancy Probability Table for Males. 26 11-2. Life EXpectancy Probability Table for Females e e e e e e e e o e e e e e e e o 26 11-3. Performance of Eight Investment Alternatives, 1955 to 1968 e e o e e e o e o e e e e e 37 II-h. Ranking of Equity Investment Alternatives in Decreasing Order of Mean Annual Dollar Returns 0 e o e o e e e e o e e o o e e e 38 11-5. Ranking of Equity Investment Alternatives in Increasing Order of the Standard Deviation of the Dollar Returns . . . . 38 11-6. Performance of Eight Investment Alternatives During a Hypothetical Depression, 1968 to 1955 . . . . . . . . . . . . . . . . . #3 11-7. Relationship Between Life Expectancy and Realized Rate of Return from an Annuity . 55 111-1. Tabulation of Survey Response by Townships . 63 IV-l. Frequency Distributions of Ages . . . . . . 67 V ”able :V'ZO Iv'an Iv'bo IY'SO IV'60 Iv.7. IV'B. IV-9. IV'lOo H.110 Pref I‘{.120 Fre: 51113. PI‘e; IV.1n. 2| 1“").5. Prey IV.16. Afifef ”‘15. PM] Fly-19. Table IV-2. IV-3. IV-h. IV-5. IV-6. IV-7. IV-8. IV-9. IV-lO. IV’llo IV‘lZo Iv-13. IV-llh IV'lSO IV-l6. IV'17 e IV-18. IV'190 Frequency Distribution of Number of Childrenoeeeeoeeeeeeoeee Frequency Distribution of Years of Formal Educationoeeeoeooeeeoeeee Frequency Distribution of Year Reapondents Started Farming . . . . . . . . . . . . . Frequency Distribution of Years of Nonfarm Work.................. Frequency Distribution of Size of Farm LaStoperatedoeeeeoeoeeeeee Frequency Distributions of Gross Farm Income Frequency Distribution of Type of Farming . Frequency Distribution of Locational PreferenceSeoeooeeeeoeeee Frequency Distribution of Geographical Preferences During Retirement . . . . . . Frequency Distribution of Housing Preferences During Retirement 0 e e e o o e e e o e 0 Frequency Distribution of Preferences for Working During Ratirement e e o o e e e 0 Preferences for Leisure Activities During Retirement . . . . . . . . . . . . . . . Frequency Distribution of Satisfactory Ratirement Income Goals 0 e e e o e e 0 Frequency Distribution of Minimum Retirement Income Requ1rements e e o e e e e e o e 0 Frequency Distribution of Total Net Worth . Average Composite Balance Sheet of the Survey Respondents e e e e e o e o o e 0 Frequency Distribution of Net Cash Income. 1968 O O O O O O O O O O O O O O O O O O Averagg Composite Net Cash Income Statement. 19 O O O O O O O O O O O O O O O 0 vi Page 67 68 69 69 71 72 7h 75 75 76 76 77 77 82 83 86 86 Table IV'ZO. IY-Zl. IY'ZZO Rah Table IV-ZO. IV-Zlo IV-22. IV-23. IV-Zh. IV-ZS. IV-26. IV-27o IV-28. IV-29. IV-BO. IV-31. v-10 V-Z. V-B. V-u. V-5. V-6. Page Frequency Distribution of Total Living COStS’ 1968 e e e o e e e e e e e e e o e 89 Average Composite Living Costs Statement. 0 e e e e e o e e e e o e e e e 90 Frequency Distribution of Income Minus LiVing COSth 1968 e e e e e o o e e e e 92 Frequency Distribution of ReSpondents' General Situation 0 e o e o e e o e e e e 93 Estate Management Programs of Survey Respondents e e e e o e o e e e o o e e o 95 Life Insurance Coverage of Survey Respondents 96 Investment Preferences of the Survey Respondents e e e o e e e e e e e e e e e 99 Reasons for Ratings of Investment Alternatives 100 Reasons Mentioned by Retired ReSpondents for LeaVing Farming e e e e e o e o e e e o e 103 Frequency Distribution of the Number of Years of Retirement (Retired Respondents Only). 103 Methods of Farm Asset DiSposal . . . . . . . 105 Financial Comparisons of Retired Respondents and Those Still in Farming e e e e e e e 106 Estimated Housing Costs for Three Types of Dwelling e e e e e e e e e o e e o o o o 115 Commission Charges per Transaction on Nonfarm securities 0 e e e e e e e o o e 119 Sources and Amounts of Potential Capital Losses for the Average Survey Respondent. 122 Relationship Between Break Even Rates of Return and Typical Capital Loss Rates . . 123 Rates of Return Needed for Capital Loss Recovery 0 e e e o o o e o e e e e o e e 12“ Ranges of Expected Total Returns From Investment Alternatives . . . . . . . . . 125 vii Table V-7. VI'le 11-2. vx.3. 11-4. VI-S. 11-6. VI-7. v1-8, VI-9. vI-lo. a» v‘.l]“. 'JVP '1-12. ‘ Vs fie]. AV! Ads: (d tn P11 Table V-7. VI-l. VI-Z. VI-3. VI-u. VI-S. VI-6. VI-7. VI-8. VI-9. VI-IOO VI-ll. VI-12. VI‘130 VI-lh. VI'lSo VII-1. Relationship Between Rate of Return and Annual Dollar Income for a $10,000 PorthliO Unit 0 o o e e e o e e o o e 0 Average Financial Situations of Low, Medium and High Net Worth Groups of Respondents. Assumed Rates of Return for Investment Alternatives-“Early 1970 e e e e e e o 0 Low Net Worth Case Balance Sheet . . . . . . Annual Living Costs for the Low Net Worth Case 0 e e e e e e e e o e e e e e e o 0 Estimated Capital Losses for the Low Net Worth Case 0 e e e e e e e e o e e e o 0 Estimated Annual Returns from the Recommended $20,000 Investment Portfolio . . . . . . Estimated Annual Returns with the Rental Alternative for the Low Net Worth Case . Estimated Capital Losses for the Medium Net Worth Case 0 e e e e e o o e o e o 0 Estimated Annual Returns from the Recommended $36,000 Investment Portfolio . . . . . . Estimated Annual Returns with the Rental Alternative for the Medium Net Worth Case High Net Worth Case Balance Sheet . . . . . Estimated Capital Losses for the High Net WC rth case 0 O O O O O O O O O O O O O 0 Estimated Annual Returns with a Land Contract Sale for the High Net Worth Case . . . . Estimated Annual Returns with the Rental Alternative for the High Net Worth Case . Estimated Maximum Annual Retirement Income . Summary of Principal Findings of Survey . . viii Page 129 133 136 137 138 139 140 1&2 105 147 148 150 152 153 150 157 162 Figure II'lo TIE LIST OF FIGURES Figure Page II-l. The Investor's Utility Function . . . . . . 21 ix CHAPTER I INTRODUCTION The Problem Area This study focuses on the disinvestment stage of the farm firm growth cycle. It examines the financial and personal problems confronting older farmers who decide to leave active farming because of age, ill health, or simply a desire for a more leisurely way of life. The magnitude of the problem of retiring from farming can be eXpressed in terms of the number of farmers who are approaching or have reached retirement age. According to the 1960 Census of Agriculture, 5h8,291 farm operators, about l7.h percent of the total number of farmers in the United States, had reached or exceeded the typical nonfarm retirement age of 65. Another 702,33h farm opera- tors, about 23.5 percent of the total, were 55 to 6b years of age. Most of the farmers in this latter age group will be faced with the problems of leaving active farming during the next two decades. About 36 percent of the age 65 and over farmers Operated "commercial farms” (Economic Classes I through V inclusive). The remaining 350,558 age 65 and over farmers 1 were Operati fer-:3 are ti'J 250 to $2.“? The census c‘ retirement f curces exce l preduc ts. A r CC‘A th911‘ activg centrol musJ income and c genera”: .10“ C 2 were operating ”part-retirement" farms. Part-retirement farms are those with a value of sales of farm products of $50 to $2,499 operated by persons 65 years of age or over. The census definition also suggests that most of these part- retirement farms are farms on which the income from nonfarm sources exceeds the value of sales of agricultural products.1 According to the Census data, then, two-fifths of our farmers are approaching or have reached the end of their active farming careers. The assets which they Control must somehow be converted to sources of retirement income and eventually they must be transferred to another generation of farm operators. Objectives of the Study Little is known about the disinvestment stage because the research effort in agricultural finance has focused on firm growth and expansion and, to a lesser extent, on the intergeneration transfer of farm assets. This study will attempt to narrow this research gap. The Specific objectives are: 1) To describe the important financial and personal characteristics of retirement age farmers. 2) To recommend disinvestment strategies which will fulfill the financial and personal goals of retirement age farmers. lU.S., Department of Commerce, Bureau of the Census, 1960 United States Census of Agriculture, Vol. II, Chapters 5 and . f 4 stage, t disinves I decides ‘t 1‘eei " b‘n far: ‘ uance, etc v. ““9 Produc t0 increas. ‘ ~ 52259, 8.73.3} 3 Description of the Disinvestment Stage The predominant form of business organization in agricultural production in the United States is the single proprietorship. In a single proprietorship, the firm growth cycle typically follows the life cycle of the propri- etor. The pattern of farm firm growth has been described as consisting of four consecutive stages--the establishment stage, the expansion stage, the consolidation stage, and the disinvestment or withdrawal stage. During the establishment stage, the proprietor decides to enter farming, and he plans the type and size of farm. He also accumulates the resource base needed to begin farming by means of renting, borrowing, saving, inheri- tance, etc. In the eXpansion stage, the resource base and the productive capacity of the firm are increased in order to increase profits and net worth. During the consolidation stage, emphasis is placed on maintaining and stabilizing the income stream.2 In the disinvestment or withdrawal stage, the proprietor, either voluntarily through planned retirement or involuntarily through illness or death, withdraws his labor, management, and capital from the business. 2J.R. Brake and M.E. Wirth, The Michigan Farm Credit Panel: A History of Capital Accumulation, Research Report No. 25. East Lansing: Michigan State University, Agricultural Ex eriment Station, Department of Agricultural Economics, 196hg. Th be a criti Fi high at th each is at liquidatim Sec establisim growth eye] but circums the disinve Thi encounter d " + ‘mm those we, . . ...e tramln technlcal a lit+l '9 help ‘ Writ), re fl , ““939 18 ve 0f . . Fir ‘1 “a . “‘fICult . II, . a!“ v- a‘gemen. 1 31“,. I N" “so T L, Importance of the Study There are several reasons why disinvestment might be a critical stage that is easily mismanaged. First, the value of the firm is usually relatively high at the beginning of the disinvestment stage: hence, much is at stake when decisions are made on the use or liquidation of these assets. Second, time may be an important factor. The establishment, eXpansion, and consolidation stages of the growth cycle may occur over a period of from 20 to #0 years, but circumstances such as illness can force the firm into the disinvestment stage very suddenly. Third, the kinds of problems which farmers may encounter during the disinvestment stage are very different from those which they deal with during the earlier stages. The training and eXperience acquired from managing the technical and financial aspects of a farm business are of little help in analyzing sale or transfer alternatives, rates of return and risks of nonfarm investments, social security regulations, estate planning, etc. Furthermore, there is very little information available on the subject of retiring from farming. Finally, the disinvestment stage may involve some difficult personal problems. _There may be family members who wish to take over the farm business and special arrangements must be made to facilitate the transfer of the assets. I11 health or the inability to adjust to a new ray of life to retireme: As ‘ farmers in reached ret vestment pr farm peeple 1:10 have a] some indie: income for 5 way of life can make the transition from active farming to retirement very difficult. As was indicated earlier, a substantial number of farmers in the United States are approaching or have already reached retirement age. A second dimension of the disin- vestment problem is the income status of retirement age farm people. The Census data do not include those people who have already left active farming, but they do provide some indication of the aggregate amounts and sources of income for those who have continued to farm beyond the age of 65. Table I-l gives a comparison of the Economic class breakdown for the under 65 and 65 and over farmers in 1960. Table I-l.--Economic Class Comparison of Under Age 65 and Age 65 and Over Farm Operators, 1960 Farm Operators Farm Operators Economic Undg; Age 65 Agg 65 and ngg Class Number Percent Number Percent Class I 132,073 5.1 9,001 1.7 Class II 200,620 9.0 15,278 2.8 Class III 033.979 16.6 33,117 6.0 Class IV 006,607 17.1 58,007 10.6 Class V 362,198 13.9 81,720 10.9 Class VI 308,272 13.3 * * Part-Time 639,009 20.5 * * Part-Retirement * * 350,558 63.9 Abnormal 2,008 0.1 120 0.1 Total 2,609,566 100.0 508,291 100.0 Source: Calculated from: U.S., Department of Commerce, Bureau of the Census. 1 U i tates ensus W. Vol. II. Chapter - The 65 and : six percent for 7.6 per: The 350,555 nf the total are percent Celt? is reported é; . 0511‘ RORfaj Security, 13‘ A“ .1 rent, 1!? “A V 6‘ .(’v.1‘am inc, A. .Vnh " half 0 i irement 1 fat \ . : 59.310313 ’ W 6 The 65 and over commercial farmers made up slightly over six percent of the total number of farmers, and they accounted for 7.6 percent of the aggregate value of products sold. The 350,558 part-retirement farmers made up over 11 percent of the total number of farmers, but accounted for less than one percent of the aggregate value of farm products sold. Census data on the nonfarm income of farm residents is reported on a household basis, and there are separate tabulations for total nonfarm income of all household members and nonfarm income of household members other than the farm Operator. These two tabulations were combined to calculate the sources and aggregate amounts of farm operator income from nonfarm sources shown in Table I-2. The under age 65 farm operators derived most of their nonfarm income from wages and salaries. Social security, pensions, etc., and investment income in the form of rent, interest, and dividends were the major sources of nonfarm income for both groups of age 65 and over farmers. Over half of the aggregate income received by the part- retirement farmers was derived from social security benefits, pensions, veteran and welfare payments. Apparently the part-retirement farmers who, by definition, receive low average farm incomes also receive comparatively less income from nonfarm sources. The part- retirement farmers averaged $810 in sales of farm products and $1,031 in nonfarm income in 1960. The 65 or over commercial farmers had average farm receipts of $13,683 and QCOEOhHPOHIQMML HTHOLMEEGU mLCPMLODO ELQR I! 00>O DEM Wfllflm< mhdafihoflo ELSA ANNSHHOQ :ficflHHfiE Cd punchlidhn P:30F. .whflflflfldflMMfilHo msmsmo moPMPm www.cp :0 H .msmcmo map mo smohsm .ooumssoo mo Pamspnmmon ..m.: .soum cmvmasoamo .monsom and.aw onw.aa :mm.~w Spam pom mSoocH Sham mmo mwmnm>< o.ooa 2A.Hom o.ooa 2m.amm o.oon 2m.amm.w Haves m.NN m.mHH n.2d N.owa o.ma m.mwa.a .opm .mccocfl>wm .pmonoch .mvnomonm sumHCoz and sham Scum Psom m.mm :.mam H.3m H.mma m.m m.oma assessed enemas: ecu smumvm> .msowmsom .hpwnsomm Hmaoom m.m n.0N o.m o.am m.ma m.mom :onmmmoum so mmoswmsm shamsoz m.ma w.mm «.ma 5.5: m.mw m.mam.: mmahmdwm and moms; condom connom monsom kam hm hm moopsom Hammmmm 925054 psmonom pssos< mmmwmmm vcsos< osoosH mmmammMI =mmmmmmmmdlmmmM:ll IIIIwMIMMdlmmmmmll psosmn pmhuphmm I! am opossoo muopmnono Sham Amuaaaon comaaaz CH monsmfim Pssos:H one: A HH mauspmm xmwm any movemex the direct Al sented by IO; is the that any p am/0r a l shaded are investor w POthOIio ’1 A o RSSets and "1 insured Sen-ted by 0, . his fuhds V" 1" «L , + '- ‘eflcblon 22 any movement down and/or to the right in Figure 11-1 is in the direction of increasing utility. All possible risky investment portfolios are repre- sented by the shaded area in Figure 11-1. The boundary IOF is the set of ”efficient" portfolios in the sense that any portfolio lying on IOF has higher expected returns and/or a lower amount of risk than any portfolio in the shaded area. The usual tangency solution shows that this investor will select portfolio 0 which lies on the highest attainable indifference curve, U2. According to this analysis. the investor, having selected the combination of risky assets represented by portfolio 0, next decides how his total available investment funds will be allocated between the portfolio of risky assets and the riskless investment. cash which is held in an insured savings account. The riskless asset is repre- sented twrpoint S on the horizontal axis. If his preference function is of the form U1, U2, U3. he will put all of his funds into portfolio 0. The investor with preference function.U4. U5. U6 would hold part of his funds in the fbrm of'cash while the investor with indifference curves U7.'U8, U9 would borrow funds to acquire additional units or Portfolio 0, which is equivalent to holding a negative balance in savings. This conceptual description of the investment Pr°blem.suggests that an investment portfolio is a highly personal matter. Individual preferences determine the indicate: the risk the port: earning 2 losing a1 asset. I greater 1 .‘T‘ investmen 3.3m .he decline b 'Pon the iated at market pr YariMme “M: ytvt',‘des d \ “eeendent I: .3. “"9Stee‘1' ‘ l to es 23 components of the portfolio as well as the proportion of funds which will be invested in risky assets. It also indicates the need for a systematic method of evaluating the risk and expected returns of the possible components of the portfolio . Defining and Measuring Risk An investor purchases assets for the purpose of earning a return. Risk is defined as the probability of losing all or part of the initial capital invested in an asset. In general. the higher the expected returns. the greater is the amount of risk which must be assumed. The probability of losing one's initial capital investnnent depends upon two factors. First. it depends upon the probability that the price of the asset will decline below the acquisition cost. Second. it depends uPon the probability that the asset will have to be liqui- dated at a time when the market price is depressed. The usual measure of the probability that an asset's market price will be less than its acquisition cost is the variance of the returns. The variance of historical returns Provides only an approximate indication of risk because the amount of risk associated with an investment is entirely dependent upon future conditions. In appraising these future conditions, four types of investment risk must be considered. Business risk refers to the probability of a decline in the asset's earning power. P share of decline i irket ri attitudes pmbabil because liQUidat ”19 indi sore ma ditures ‘ "he“ thei im’estoz. Mays be maxP'EC’ce \ 21 of i 0 “98h am Equi 2h power. For example. a decline in the net earnings per share of a company will. ceteris aribus. result in a decline in the price of that company's common stock. Market risk refers to the probability that investors' attitudes toward an asset will change. even in the absence of any fundamental change in earning power. For example. if a large number of investors decided that farmland was no longer a good investment. the price of farmland would. ceteris aribus. decline. Interest rate risk refers to the probability that the general level of interest rates will increase. An increase in interest rate level will. ceteris aribus. result in a decline in the value of an income producing asset. Purchasing power risk is the probability that the real value of the asset will decline because of an increase in the general price level.2 The probability that an asset will have to be liquidated when its market price is depressed varies from one individual to another. A wealthy investor who receives more than enough income to meet his day to day cash eXpen- ditures would be less likely to have to liquidate assets when their prices are temporarily depressed: however. the investor who has a low net worth and a low income should always be in a position to sell some of his assets to meet unexpected expenditures. In general. a wealthy investor 2For a more detailed discussion of the four types of investment risk see Kost. “Investing in Farm and Non- farm Equities.” pp. 8—ll. or one v accept a who is J diture 3 for the dated to the even Ii-Z con from the cheetah 0f retir differen indicate: °f reach; ”0 Yea} age 90. in"extol: Pm‘babilj We? of willing t of gems . 25 or one whose expenditure pattern is relatively stable can accept a more variable stream of returns than an investor who is less wealthy or who has a highly variable eXpen- diture pattern. Older investors. such as retired farmers. must allow for the possibility that their assets may have to be liqui- dated to pay for uneXpected medical expenditures or. in the event of death. to settle the estate. Tables 11-1 and 11-2 contain life eXpectancy probability data calculated from the 1959-61 United States Life Tables.3 These life expectancy probability tables show. for the typical range of retirement ages. the probabilities associated with different remaining lifetimes. For example. Table 11-1 indicates that a 70 year old male has a 9 percent chance of reaching the age of 90. and Table 11-2 indicates that a 70 year old female has a 15 percent chance of reaching age 90. Although life expectancy functions are nonlinear. interpolation can be used to obtain accurate estimates of probabilities not shown in the tables. These tables are also useful for estimating the number of years for which retirement income will be needed. A retiree with a low net worth might wish to gradually use up his capital to cover his living costs and he may be willing to assume. say. a 20 percent chance of running out of funds before he dies. In this case. a 70 year old couple 3U.S.. Department of Commerce. Bureau of the Census. United States Life Tables: 1252-61. Table II _—-—-—— ”—- 0 I team: 9 ' e l ' 419.1% (Years 26 Table II-1.--Life EXpectancy Probability Table for Males - t ‘— 1 Remaining p es t Lifetime _50 55 60 r 6? Age70 Z5 80 (Years) Probability of Remaining Lifetime 5 .94 .92 .87 .82 .75 .65 .50 10 .86 .80 .71 .61 .48 .32 .18 15 .75 .65 .53 .39 .24 .ll .04 20 .62 .49 .34 .20 .09 .02 * 25 .46 .32 .17 .07 .02 * * 30 .30 .16 .06 .01 * * * 35 .15 .06 .Ol * * * * 40 .05 .01 * * * * * [4,5 .01 'I- ‘I- 'I' ‘I is *- Mean Life EXPGCtancy 2302 19.“ 1600 1300 1003 709 509 *Indicates probability of less than .01. Table II-2.--Life EXpectancy Probability Table for Females Remaining Present Age Lifetime 550 55, 60 65 70 75 80 (Years) Probability of Remaining Lifetime 5 .97 .96 .94 .90 .84 .74 .58 10 093 090 082+ .75 062 0&3 .23 15 087 081 070 055 .36 017 .05 20 . .78 .67 .52 .32 .14 .03 .Ol 25 .66 .50 .30 .13 .03 .01 e 30 .48 .29 .12 .03 * * * 35 .28 .11 .02 * * * * 40 .ll .02 * * * * * “5 .02 e * i a i * Mean Life EXpectancy 28.1 23.8 19.7 15.9 12.4 9.3 6.7 *Indicates probability of less than .01. shauld p3 years to the freq mtbeu rezainir only 10. figures 350 per death. data re; 05 the U for the example, lc'fler pr 27 should plan for about 16 1/2 years for the husband and 18 1/2 years for his wife. This example illustrates clearly why the frequently cited mean life expectancy statistics should not be used in planning retirement income needs. The average remaining lifetimes for a 70 year old man and woman are only 10.3 years and 12.4 years respectively. If these figures were used. the couple would be assuming approximately a 50 percent chance of using up their assets before their death. It should be remembered that these life expectancy data represent the average experience for the white population of the United States and the estimates should be adjusted for the physical condition of the individual user. For example. a 70 year old who is in poor health would have a lower probability of reaching age 90 than the data indicate. Defining and Measuring Returns The total rate of return from an investment consists of two components: an income rate of return and a price :rate of return. These two components are also referred to (as realized and unrealized income. since income which results from.an increase in the price of an asset presumably cannot 'be used until the asset is sold. Boyne argues that unrealized income does affect the asset owner's welfare because he can :reduce the amount of saving from conventional income and still me In the 2 {3.218131 consider to conve suggests holdings tional i less val 0f unrea hence, t the com lized in convene heldi cc C. Sales co: income a: 15' 0‘ the l( ‘ ax Sa‘tii 28 still maintain the same rate of increase in real wealth.a In the analysis of investment alternatives for retiring farmers. both the price and income rates of return are considered. Even though unrealized income can be "converted” to conventional income either by reducing savings as suggested by Boyne. or by actually liquidating a part of the holdings of the asset whose value has increased. the conven~ tional income or yield from an asset is normally more or less valuable to the investor than an equal dollar amount of unrealized income. Conventional income is more certain: hence. the investor uses a lower discount rate in valuing the conventional income stream than he would for the unrea- lized income stream. Also. if unrealized income is converted to conventional income by liquidating asset holdings. the investor must pay selling costs in the form of sales commissions. etc. For some investors unrealized income may be worth more than conventional income because of the lower marginal tax rate on capital gains. Thus. the tax saving might offset the uncertainty and selling expenses associated with unrealized income. It is difficult to say a pzigri whether an individual investor would prefer conventional income or unrealized income. Kost defines the total rate of return as R1: = Ryt +)‘RPt where Rt is the total rate of return. Ryt is ”David H. Boyne. Chan es in the Real Wealth Position a 40-1 60. Technical Bulletin 294 zEast Lansing: Michigan State University. Agricultural Experiment Station. Department of Agricultural Economics. 1964). p. 30. the incorr. return an income ve greater t he attae exaected 29 the income rate of return and Rp is the price rate of t return and Atis the relative importance attached to unrealized income versus realized income. He suggests that )tmay be greater or less than one depending upon the relative weight 5 one attaches to the two sources of income. Desirable Investment Characteristics A desirable investment should offer a high level of expected returns and a low probability of capital loss. The preceding discussion suggests that both returns and risk must be analyzed within the context of the individual investor's situation. The amount of expected returns and risk associated with an asset are related to three important investment characteristics--liquidity. management requirements. and leverage. Liquidity refers to the ease with which an asset can be bought or sold. An asset should be readily marketable and it should be capable of being traded in small units. .An asset which can be sold quickly. at low cost and in small units is preferable to one which requires a longer period of‘time and/or greater expense to liquidate. Liquidity is important because it permits the investor to convert price returns to conventional income returns very readily. 6 5Kost. ”Investing in Farm and Nonfarm Equities.” p. 10 no... Settles-l ‘litxi. t't 30 An investment portfolio should be easy to manage. Assets which can be safely purchased after only a small amount of analysis are preferable to assets which require extensive analysis prior to purchase and close supervision thereafter. This management factor implies that investors should generally restrict their purchases to familiar investments on which accurate information is readily available. Leverage refers to the relative amount of borrowed funds which can be used to purchase an asset. As long as the rate of return exceeds the cost of borrowed funds. the investor can increase the net return on his equity by borrowing to purchase additional units of the asset: however. the use of leverage also increases the probability of losing the initial capital investment. The leverage factor is an important consideration for many investors. but the negative attitude toward debt expressed by many older farmers indicates that leverage is probably not important to most retiring farmers. An Analysis of Eight Investment Alternatives Asset classification In selecting assets for a retirement income port- folio. it is first necessary to decide on the relative proportion of equity assets and fixed income assets. Equity assets such as common stocks and farmland entitle the investor to the usual rights of ownership. the most important being the right to participate in management decision; Fixed-in the inve firm, a: partie, 1' inceme tmeal and mar to inte PNVideS 5‘) 0: Set Whj o”: “Xe. .1,” ‘ V 31 decisions and receive a proportionate share of the profits. Fixed-income assets such as bonds or land contracts entitle the investor to only a limited share of the profits of a firm. and generally. they do not afford him the right to participate in the management of the business. The distinction between equity assets and fixed income assets is very important because equity assets typically involve a greater degree of both business risk and market risk. while fixed income securities are subject to interest rate risk and purchasing power risk. The assets analyzed here were classified as follows: Equity assets: Farmland Common stocks (industrials and utilities) Mutual funds (“growth" and ”income") Fixed income assets: Corporate bonds Government bonds (long and short term) This list. while not exhaustive in any sense. is representative of the investment alternatives which might be considered by the retiring farmer. The list also provides a standard of comparison for analyzing other alternatives. For example. nonfarm real estate is an equity asset which can be compared with farmland. common stocks and mutual funds. Land contracts and savings accounts are fixed-income assets which can be compared with the bonds. invests. investme held um Were not to aCCuz t0 the 1 \ are an 1an.‘Stri Poer's T 32 P f anc c ia Each of the investment alternatives was examined in terms of how well it fulfills the following criteria: 1. Expected returns 2. Variability of returns 3. Risk 4. Management requirements 5. Liquidity Em ° i a sis of hisrorical performance The expected returns and the variability of these returns were estimated empirically for each of the eight investment alternatives assuming that a hypothetical investment of $1000 was made in 1955 and the security was held until 1968. It was assumed that the income returns were not reinvested and that any capital gains were left to accumulate. Published price index data were all adjusted to the 1955 base year for purposes of comparison.6 6The sources of the price indexes and annual yields are as follows: Industrial stocks. utility stocks and bonds: Standard and Poor's Trade and Securities Statistics. Sgcgriry Price Index ggcgrg. 1968 Egixign ,(Oran e. Conn.: Standard and Poor's orporation. Publishers. l9 9). Mutual funds: Arthur Wiesenberger Services. I v tment -- u unds 0 he es New York: Nuveen Corporation. 19 9 . p. 121. Farm real estate: U.S.. Department of Agriculture. Economic Research Service. Farm Production Economics Division. - 23W. Vol- 30. Supplement (Jam 1970 - ad 33 Investment results were computed in the usual manner as an annual percentage rate-of-return based on the asset value at the beginning of the preceding year. In addition. the annual dollar returns were also computed. Many retired persons are dependent upon their investment income for living expenditures: hence. they are particularly interested in the amount and variability of these dollar returns. Because of changing asset values. rankings among the alter- natives based on year-to-year rates of return would not always be the same as rankings based on the dollar returns. \ The year-to-year variability of returns is indicated by the standard deviations of both the dollar and annual rates of return. The standard deviation should be inter- preted only as an indication of variability. not as a complete measure of risk. It does partially indicate the degree of risk because a high standard deviation for the price returns would suggest a higher probability that the asset's price might be much lower than its acquisition cost at any given time. Limitations of the empirical analysis One shortcoming in the empirical analysis was the use of aggregated index and yield data. The degree of diver- sification implicit in an aggregate series cannot possibly be achieved by the individual investor. Other shortcomings arose from deficiencies in the data. In order to achieve comparability. price index and 1'... .9 .. 34 annual yield data were needed for all eight alternatives. The farm real estate price index for the State of Michigan was used because it best represents the experience of the Survey respondents. The only available annual yield data for farm real estate were for the entire United States. The Standard and Poor's Corporation data on stock price indexes and yields were used because they are widely recognized as being the best indicators of total market performance. The Standard and Poor's bond price indexes were unsuitable for this analysis because they indicate the current bond price assuming a constant number of years to maturity. For example. both the 1955 and 1968 price indexes for corporate bonds assumed that the bond carried a nominal coupon yield of 4 percent with 20 years-to-maturity. Actually. a 20 year-4 percent bond purchased in 1955 would have only seven remaining years-to-maturity by 1968 and its price would be higher than that of a 4 percent bond which still had 20 years-to-maturity. The bond price indexes used in this study were calculated from actual yield data by discounting the remaining annual coupon income and the face value at the current yields for each year covered by the study. There are several published indexes of mutual fund performance. however. those constructed by Arthur Wiesenberger Services are the only ones which were comparable with the price and yield data on the other investment alternatives. The other mutual fund price indexes are based on the 1‘5 hU 35 assumption that all. or part of the income returns are reinvested annually. Unfortunately. the Wiesenberger indexes go back only as far as 1958. It was assumed that the price performance of both the growth and income funds between 1955 and 1958 was the same as the Standard and Poor's index of 500 common stocks. This assumption would tend to underestimate the mean return of the growth funds and overestimate the mean return of the income funds. The Wiesenberger indexes are computed for four types of funds--growth funds. growth income funds. balanced funds and income funds. Growth funds and income funds were selected because they represent the two extremes in relative emphasis on capital gains and dividend income yield. These indexes are based on the combined experiences of only five of the largest funds in each category and the basis for selecting these five funds is somewhat obscure. Thus. the indexes probably do not adequately reflect the overall performance of all mutual funds. All investment alternatives were based on a net initial investment of $1000. That is. acquisition costs such as brokerage commissions were disregarded. Brokerage commissions and other purchase costs typically vary with the amount purchased and with the individual investor's situation. The omission of brokerage fees from common stocks and bonds does not seriously affect their relative positions: however. in some cases adjustments must be made for the costs associated with purchasing and selling mutual ‘Pllsfv .hfl 0“ 36 fund shares and farmland. With the exception of approximately 70 ”no load” funds. mutual funds charge a sales commission of between 8 and 9 percent of the amount purchased. In the case of farmland. the typical retiring farmer would have to consider capital gains taxes and added housing costs in addition to the realtor's commission if he were to sell his farm and invest in other securities. Results of the empirical analysis The means and standard deviations of the price returns. income returns and total returns for all eight investment alternatives are summarized in Table II-3. All results were rounded to the nearest dollar or one-tenth of one percent. The growth funds and Standard and Poor's index of 425 industrial stocks were the two best equity alternatives in terms of mean annual total dollar returns. The relative ranking among the five types of equity assets depends upon whether the investor prefers price returns or income returns. Table II~4 shows these alternative rankings. In general. the rankings would be the same if based on mean annual percentage rates of return. The relative ranking of the equities on the basis of the variability of returns is shown in Table II-5. Farm real estate provided much more stable total dollar returns than the other four equity assets: however. it ranked fifth behind all other equity alternatives on the basis of the stability of the income returns. 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NH. 8 N2 EL. 38 m625h Spsouo exoopm sesame: nsoopm asanpnsssH wossm wsoosH mpmpmm Hsmm sham mpmpmm data such nsooem mamas»: exooem HeahpmsesH eases spaces macaw osoosH macaw £930Ho nsoopm sesame: naeoem HeaepnsesH mocsm oaoosH mpmvmm Hmmm sham FINN—'1“ menseem Hesse mauspum osoosH unhapcm nmaaon one mo compmw>ma camcsmvm one mauspmm coaum 32mm mo umcpo wsHmmouosH a“ mm>wpmcnovad passpmo>sH hpwsdm mo mafixsmm::.m:HH manna .Hdsvm who: mchsvmu osoocam mpdpmm Hmmm Sham mocsm meoonH exeoem apaaapp axoopm HeanpnsesH macaw npzonu mossm npsouw evapmm Hamm Sham enseoem HeaaensesH amcssm osoocH esooem sedan»: mossm assess meoosH evapmm doom sham nsoopm spade»: nsoopm suspensesa asses assess assess Hmmaxn nahseem fleece unhapom osoocH mansvom moaum Mada nauseom ndHHon Haszc< cums mo Macao wammouooQ CH mo>dpasnopad Passpmo>sH zvdswm Ho m2wxnmm::.s:HH wands 1‘ 39 of a farm business is subject to exogeneous factors such as weather conditions and market prices: thus. farm real estate held either as part of a farm business or rented out on a share lease would be expected to yield a highly variable income return. Very few general recommendations for choosing equity assets can be made because the choice depends upon the individual's preferences for returns and the variability of these returns. Most retiring farmers presumably require high returns and the stability of these returns is important. Industrial stocks which ranked second in mean annual dollar returns and third in variability would. on the basis of past performance. appear to be a suitable alternative for the retired investor who is concerned mainly with total returns. The retiree who desires high income returns and low varia— bility might consider the income mutual funds which ranked second in mean annual dollar returns and first in stability. The period 1955 to 1968 was one of generally rising interest rates and the price returns performance of the three types of bonds illustrates the effects of interest rate risk and purchasing power risk on the performance of fixed income securities. The price and income returns of all five types of equity assets increased by more than enough to compensate for inflation induced purchasing power losses but the prices of the bonds showed an absolute decline. as shown in Table 11-3. 40 Some fixed income assets should probably be included in all investment portfolios. They tend to stabilize the income stream and capital gains can be realized during periods of falling interest rates. Fixed income securities also provide a hedge against a severe general decline in equity prices such as the one which occurred in 1929. During a period of rising interest rates. however. the fixed income securities should be short term. preferably less than five years to maturity. because long term bonds involve a greater amount of eXposure to interest rate risk. The 15 year government bonds which carried a nominal coupon yield of 2.8 percent in 1955 would have provided an annual income return of $28 but the mean total return was only $24. The investor who initially purchased a lower yielding 2.4 percent. four year maturity government bond in 1955. held it to maturity and reinvested in another four year government bond at the prevailing and generally higher. yield. etc. would have earned an average of $34 per year. Under the ”buy and hold" policy assumed in this analysis. both the long term government bonds and the corporate bonds would have provided completely stable dollar income returns. assuming that the bond issuer did not default on the annual coupon obligations. In the case of the government bonds the probability of default is negligible: however. corporate bonds do occasionally go into default. 41 Performance of the eight investment alternatives during a hypothetical depression A serious limitation which is common to most studies of the historical performance of securities is the use of a specific time period. The period 1955 to 1968 used in the preceding analysis was one in which interest rates. corporate profits and the general price level all increased. These conditions accounted for the favorable performance of all five types of equity assets and for the comparatively mediocre performance of the fixed income securities. The investor who believes that similar conditions will continue to prevail in the future should devote a relatively large proportion of his portfolio to equity securities: however. if profits and interest rates are expected to decline. fixed income securities would provide better results. In order to illustrate the performance of the eight investment alternatives under less favorable economic conditions. the data on their performance were examined in reverse order. i.e.. it was assumed that an initial net investment of $1.000 was made in each alternative in 1968 and held until 1955. A few of the characteristics of this hypothetical "depression” are worth noting. For example. the yield on high grade corporate bonds would have declined from 6.1 percent to 3.0 percent. The Standard and Poor's index of 500 stocks would have declined from 99.1 to 40.5: however. the yields on common stocks would have increased slightly from 3.2 percent to 4.1 percent. The average value 42 of farm real estate in Michigan would have declined from $294 per acre to $136. The consumer price index of all goods and services would have declined from 120.9 to 93.3. The summary of the performance of the five equity assets and three types of bonds during the hypothetical depression period is given in Table 11-6. The fixed income securities would have out performed the equity assets on the basis of both the amounts and variability of the returns. Capital losses on the equity assets would have ranged from an average of $36 per year on farm real estate and the income mutual funds to $52 per year on the growth mutual funds. These losses would have been partially offset by the income returns: however. holders of any of the five equity assets would have incurred net losses. The superiority of the higher yielding longer term bonds when interest rates decline is evident from the relative performance of the fixed income securities. The investor who initially purchased a 6.1 percent. 20-year corporate bond would have received average total returns of $76 annually. The purchaser of the lower yielding four year government bonds would have received an average of only $44 annually. The comparative performance of the eight investment alternatives under the actual conditions which prevailed from 1955 to 1968 and under the conditions which prevailed during the hypothetical depression clearly illustrate why the investor must make an accurate forecast of the future. The symmetry of the analyses for the periods of prosperity and 43 m.a 3.: ma as m.o m.: m m: s.a H.o ea H meson .p>oo shoe steam ~.~ n.m mm mm «.0 0.: 0 mm H.N s.o «N s meson .peoo Shoe mCoA m.m s.a em as m.o m.m o as ~.m s.a on ma meson epsnoanoo mpmmmd meoocH ooxam m.ma H.e- mm ms- H.o m.a s m.mH s.s- em mmunessm .pss seesaw s.m m.o- so a - s.o H.s mm s.m s.s- so em-nessm .pss esoonH 0.0 m.H- am as. e.o e.m on m.m ~.m- we as- axoopm sedan»: dBMN m.m m.n- an em- m.o ~.m Hm e.m m.e- em as- axoopm .pmsesH N.m s.a- ea OH- o.a s.n as am s.m m.s- am an- eespnm deem sass mvmmms sysadm .>oa cams .>oo cams .>mn cams .>mn new: .>mo cams .>mn sum: .epm .eem .eem .epm .eem .epm seem H.ss< nasaaoa seem H.ss< nesaaon seem H.ss< meeaaon Ilummmmmmmlflmwmfllll IllmmmmmmmlmammmMIl IlllmmmmHMMIMMAMMII till $|1ll mmma op mama .aoanmeaaea Hsoapsapoaam a meansa mm>apmsnmpad vsmspmo>cH pawam mo mosmsuomuom::.o:HH wanna 44 depression is useful for determining basic investment strategies. For example. if the probabilities of prosperity and depression are 80 percent and 20 percent reapectively. he should try to achieve a correSponding balance between the equity and fixed income assets in his portfolio. 0 her v stm ite ia The selection of assets cannot be based entirely on historical performance. This section examines the alter- natives on the basis of how well they fulfill the other characteristics of a desirable investment. Farm real estate Perhaps the most important advantage of farm real estate as an investment alternative for the retiring farmer is the fact that he already owns it. There are no acqui- sition costs and it is a familiar investment. Also. whether he operates a farm business or rents the land to a tenant. he can exercise a considerable degree of control in managing the asset. Keeping the farm real estate is also consistent with many of the non-financial retirement goals of retired farmers. There are two main disadvantages associated with an investment in farmland. First. for elderly persons. it can be difficult to manage. Second. it does not fulfill the liquidity requirement of a desirable investment. Many older farmers and landlords may be unable to generate a satisfactory income return from their farm assets. a AH E3“. in unit conv pose: as a sent land thur ! r to t 45 Operating a viable farm business or finding and retaining a good tenant can be difficult for an elderly person. These management problems would be even more serious for a surviving widow. Farm real estate fails to meet the liquidity require- ment of a desirable investment because. although it can be sold relatively easily. it cannot generally be sold in small units. Thus. it is not possible to convert price returns to conventional income by gradually selling part of the asset. In some situations. keeping the farm real estate dur- ing retirement is probably the best alternative. It may be possible to continue farming with the help of a family member as a partner. In this case. an equitable partnership agree- ment should be drawn up.7 When the demand for rental farm- land is strong. renting the farm out on either a cash or share lease should provide enough retirement income. A cash lease would generally provide a slightly lower but more stable retirement income.8 If the farm is rented out. the retiring farmer and tenant should use a written lease agreement which insures that both parties share of the income is proportional to their respective share of the expenses.9 7See Hill. Earner-Son Fgrrigg Agreements. 8Huff found that the average rate of return from share- crop leases was 40 percent higher than that of cash leases. See Huff. "Land Values and Valuation". 9F.J. Reiss. Whar is a Fair Crop-Share Lgasg7. Circular 918 (Urbana: University of Illino s. Co-operative Extension Service. 1965). .v..- u_., fifi'fiw HUM.“ hiSt indt ~ h HIE. ht;\' V“ hate tett Prov H: 46 If a partner or tenant is not available. the elderly farmer would be well advised to liquidate his investment in the farm real estate and chattels before he is forced to do so because of ill health or other adverse circumstances. In general. the liquidation value of an on—going. properly managed farm business will be much greater than the value of a business which has been allowed to deteriorate because of the operator's age. Common stock Two groups of common stocks were analyzed for their historical performance. Standard and Poor's Index of 425 industrial stocks represents about 80 percent of the total number of shares listed on the New York Stock Exchange. and it consists of what may be regarded as high grade industrial corporations: that is. larger companies with established earnings and dividend records. The Standard and Poor's index of 55 utility stocks represents the type of stock which retired persons are generally interested in. Typically. the utilities offer higher income yields and a steady growth in value. It should be noted that many industrial stocks also have similar characteristics. Common stocks fulfill the liquidity requirement much better than farm real estate. Historically. stocks have also provided higher total annual returns. but both the industrial and utility stocks have yielded higher find more stable income returns. 47 The most important disadvantage of common stocks for the retiring farmer is their management requirements. Common stocks must be carefully analyzed prior to purchase and the portfolio must be closely supervised thereafter. Fundamentally. selecting common stocks is similar to finding a good tenant or deciding how a farm business will be operated. Management ability. financial strength. market prices and other factors which will affect the profitability of the business must be considered. However. the analysis of common stocks requires information to which a majority of retirement age farm people do not have access. Another disadvantage of common stocks is their high degree of market risk. A change in investors' attitudes. particularly among the large institutional investors. can cause the price of a stock to decline severely within a few hours even though there may have been no real change in that corporation's earning power. In general. common stock investors tend to collectively overreact to both favorable and unfavorable reports about a corporation's profit potential. Although the novice common stock investor is handi- capped by his lack of experience. the potential advantages of common stocks for many retiring farmers are great. People who are totally unfamiliar with the subject should read one or two good textbooks on securities analysis and become familiar with the sources of current and historical information. A portfolio of high grade common stocks purchased at reasonable prices can be expected to provide stable income way-R TIE to ar. 48 returns. In addition. the price returns will more than compensate for losses in purchasing power due to inflation. The high liquidity of common stocks also permits the investor to convert price returns to conventional income at any time-- an important feature for most retired farmers. Mutual funds Mutual funds are open-end investment companies. That is. they continuously offer new shares for sale and they always stand ready to redeem outstanding shares in cash at the current asset value. The current asset value is the market value of all securities in the fund's portfolio. There are also closed-end investment companies whose securities are traded like any other corporate issue. The price of the common stock of a closed-end investment company maybe above or below the current asset value. The most frequently cited advantage of buying mutual fund shares instead of common stocks is that the mutual funds provide the small investor with needed diversification and they relieve him of the time and expense of analyzing and selecting his own securities. The mutual fund portfolios are managed by professional securities analysts who use information and facilities which are not generally available to the small investor: thus. their performance should be superior to that which the novice investor could achieve. The investor can select a fund with investment objectives which are similar to his own and generally. he can convert his shares to cash at any time. 49 There are several disadvantages associated with 'mutual funds. First. the initial selection of one or two funds from the approximately 550 available poses a problem. This selection must be made with great care because many funds have exhibited consistently poor performance. Several studies of the records of mutual funds have concluded that the overall performance of the funds has been no better than the individual investor could have achieved from a random selection of common stocks.10 The high sales commissions. commonly called ”load" fees. charged by most mutual funds constitute a disadvantage for the short-term investor or for the investor who must be prepared to liquidate all or part of his portfolio on short notice. In addition to the sales commission of 8 to 9 percent of the initial purchase price. most funds charge an annual management fee of about 1/2 of 1 percent of the average net asset value. Many of the contractual plans call for payment of the “load fee" during the early years of the contract. The net effect of these fees is to substantially reduce the investor's net return below that which he could have achieved by purchasing his own securities. particularly if he finds it necessary to liquidate his shares within a few years after purchase.11 The prospective purchaser of mutual 10For example. see Irwin Friend and Douglas Vickers. "Portfolio Selection and Investment Performance.” Thg gggrnal erfigngrrg. Vol. XX. No. 3 (September. 1965). pp. 391- 13. 11For a good analysis of the effect of the load fees on returns. see Stuart B. Mead. ”Mutual Funds from the Investors ViewPoint.” MSU Bgsingss Tgpics (Winter. 1967). pp. 45-53- 50 fund shares should be aware that there are approximately 70 ”no load” funds which do not charge a sales commission. although. many no load mutual funds charge a redemption fee when shares are liquidated. Shares in the no load funds can be obtained either through a brokerage firm or by correSponding directly with the head office of the mutual fund. Since the portfolios of mutual funds consist mainly of common stocks. their performance can be expected to be similar to that of a personally selected portfolio of stocks. In general. they can be regarded as a good substitute or compliment for other equity assets in the portfolio. Retiring farmers would be well advised to consider mutual funds. They should select a small to medium sized mutual fund which has objectives similar to their own. Generally. this would mean a fund which emphasizes a stable annual income return with a moderate capital gain. Funds which restrict their portfolios to the stocks of certain "emerging” or ”growth” industries should be avoided. Contractual plans which call for the purchase of a Specified number of shares at regular intervals would generally be unsuitable for a retired farmer: however. a younger farmer who wishes to save money for retirement might use one of these regular investment plans. An attempt should be made to select only those funds which have exhibited consistently good performance over a period of several years in both ”up" and ”down” markets. R‘Sfi iii a IR? r‘vu ‘V‘A $1.8 A: h: a... #9 .s... h... Se in .1 Au. vv. 3. «r- A: Q» :4 a. . A: E e r o. 6 e 1“ t AI- H" fl.‘ 1’“ \ AH} QM AN.- flmv H. o l C Y: V an d the ale m . .3 -t.‘ .fl.‘ t... a .. a my $0.. “'7er RV Dirill i t t 1b 51 This is difficult since in recent years. at least. the top performing funds during rising markets have been among the poorest performers during declining markets. Bonds and other fixed- income securities The three types of bonds have exhibited very poor historical performance compared to the equity assets. However. during a period of historically high interest rates. both corporate and government bonds would be an excellent investment for retired people. Bonds are an excellent investment in terms of both liquidity and management requirements. Government bonds can be purchased safely without any analysis and they can be resold at any time through a brokerage firm or a bank. Corporate bonds do require some analysis and super- vision because they are subject to business risk. A corpor- ation which eXperiences a drastic decline in earnings may default on its bond interest payments. and a complete business failure often results in the loss of at least part of the face value of the bond even if it is held to maturity.12 The purchaser of corporate bonds should also realize that 12Since 1944 the default rate on corporate bonds has been very low. Between 1944 and 1965. 120 corporate bond issues having a total par value of $496.1 million went into default. This default rate was less than 0.1 percent of the total par amounts outstanding. Only 45 of the issues offered after 1943 went into default. See Thomas R. Atkinson. Trends in Corporate Bond Qualiry. Studies in Corporate Bond Finan- cing Number New York: National Bureau of Economic Research. Columbia University Press. 1967). pp. 42-49. tageox inveS‘ financ bond 5 usua.l inanc coaxor same I fixed both i additi man (It) ( 52 most corporate issues carry a "call” provision. meaning that the bond issuer reserves the right to retire the bond at the issuer's option prior to maturity. Generally. bonds are more likely to be called under conditions which are advan- tageous to the issuer and disadvantageous to the bond investor. that is. when prevailing interest rates on new financing are lower than the coupon rate on the bond. If a bond is called. the investor then must repurchase a new and usually lower yielding bond.13 Many retiring farmers who sell their farms provide financing for the purchaser through a mortgage. or more commonly. a land contract. Land contracts suffer from the same basic disadvantages as do bonds. mortgages and other fixed income securities. i.e. they involve a high amount of both interest rate risk and purchasing power risk. In addition. land contracts lack the liquidity and ease of management associated with bonds. The investor who is forced to liquidate a land contract must find a buyer in a very limited market and often he must accept a substantial discount in order to convert the contract to cash. Land contracts require a careful analysis of the potential borrower's repayment ability and some supervision is required after the loan is made. The land contract does offer ‘protection against default: however. selling the pr0perty 13For a more complete discussion of the effects of the call feature see Harold C. Fraine and Robert H. Mills. ”Effect of Defaults and Credit Deterioration on Yields of Corporate Bonds." The Jo rn of F na ce. Volume XVI. No. 3 (September. 1961). 27n. the he 11 at" lare a 1‘6 53 to satisfy past due payments under a land contract is usually a distasteful procedure. particularly for an elderly person. In certain cases. the potential advantages of land contracts may make them superior to bonds. The sale of the farm on a land contract with a downpayment of 30 percent or less permits the seller to spread the capital gains tax over the repayment period of the contract. A land contract may help to sell the farm at a higher price because the avail- ability of low equity financing will generally attract a larger number of potential purchasers. In certain cases. a retiring farmer may be able to sell the farm on a contract and retain a life interest in the farm dwelling. This type of arrangement would have obvious financial and personal benefits for many retiring farmers. Another type of fixed income security which is frequently recommended for retirement income purposes is the annuity. Annuities are contracts sold by insurance companies which guarantee the purchaser a monthly or annual income for as long as he lives. Generally. if the purchaser dies relatively soon after the income payments begin. the payments are made to his estate or survivors for a specified addi- tional period of time. If he should die before the payments begin. the cash value of the contract would be paid to his estate. Some annuities provide a specified amount of income. Variable annuities typically provide a higher income which may vary slightly depending upon the returns from the insurance company's investment portfolio. eirt inve secu rese 54 The most important advantage of annuities is the virtually certain lifetime income. Insurance companies invest the funds derived from annuity sales in high quality securities and in addition. they are required to carry reserves to protect the annuity holder. An important disadvantage of annuities is their comparatively low rate of return. Annuities cannot be compared directly with other investment alternatives because the actual rate of return to the purchaser depends upon how long he lives. Table II-7 shows the number of years needed to realize specified rates of return. In this example. a 65 year old male pays $10,000 for a variable annuity contract which currently pays an annual income of $900 for life or for 10 years certain.lb The probabilities of realizing any particular rate of return can be obtained from the life expectancy data presented earlier in this chapter. For example. a 65 year old male has a probability of 0.4 of living to age 80 or beyond. thus. he has a probability of 0.4 of realizing a 4 percent rate of return. The proba- bility that he will realize an 8 percent return is only about 0.03. Based on the mean life expectancy of 12.9 years for 65 year old males. this annuity offers a rate of return of only about 2.2 percent. 1”The data for this example were furnished by the Lansing. Michigan. office of the Massachusetts Mutual Life Insurance Company. O) 65 y; arm; 55 Table II-7.--Relationship Between Life Expectancy and Realized Rate of Return from an Annuitya Rate of Return Number of Years (Perc ent) of Life EXpectancy 11.8 12.7 13.7 15.0 16.6 18.9 22.2 28.6 ooxlomemNH aBased on a $10,000 variable annuity contract for a igngzifyfld male which pays $75.03 per month or $900 Annuities offer no protection against inflation. and the purchaser of an annuity virtually gives up the cOntrol of his capital. Once the income payments commence. the contract cannot be sold or converted to cash. The most highly liquid fixed income assets are the various forms of savings accounts. savings certificates. Certificates of deposit. etc. Aside from purchasing power risk, savings accounts are virtually risk-free. but they l“Qili'lually provide comparatively low rates of return. Liquid funds are an important part of the investment portfolio becaUSe they permit the investor to meet uneXpected 56 expenditures without liquidating other securities at a possibly inopportune time. i.e.. when market prices are temporarily depressed. Summary The composition of a retirement investment portfolio depends upon the individual's preferences for risk and returns. Some investors are willing to accept a highly variable and less certain income to achieve high returns. Others are willing to sacrifice returns for stability and greater certainty. In this chapter. the historical returns and the variability of these returns was analyzed for eight invest- ment alternatives which might be considered by retiring farmers. The performance of these alternatives during a hYPO‘tzhetical period of economic depression was also studied. These analyses illustrate the importance, of varying the Proportions of fixed income and equity securities in the Portfolio according to the outlook for future economic c0nditions. The empirical analysis is useful for estimating exPected returns and returns variability under varying Economic conditions: however. the selection of assets for an investment portfolio must also be based on their exPosure to risk. their management requirements and their 1chnudity. All of the investment alternatives have certain important advantages and disadvantages for retiring farmers. T600 WETE A “See: CHAPTER I I I SURVEY PROCEDURE To learn more about the wide range of situations contronting retirement age farm people. a small sample of farmers and retired farmers was drawn and personal interviews were conducted during July and August of 1969. This chapter contains a description of the procedure used in this survey. Definition of the Population The population was defined as farmers and retired farmers age 60 or over. including people who had worked at full or part-time jobs throughout their farming careers. Farmers were defined as full owners. part-owners. or tenants who had operated farms for at least 10 years and who were recognized as farmers in their communities. The minimum age of 60 was used so that the population would be limited to PeOple who were personally concerned with retiring from aetive farming. People who had retired to the farm from a 1“C’leif'aJem occupation and pe0ple who left active farming SEVeral years before retirement age to take up a nonfarm °c<>upation were excluded from the population. 57 58 Sampling Procedure The reSpondents were selected randomly from an area in Southern Lower Michigan which. according to the 1964 Census of Agriculture. accounts for about 80 percent of the state's gross value of agricultural sales.l Ten townships were selected from the sampling area. The probability that any particular township would be selected was weighted according to the total number of farms in each township enumerated in the 1959 Census of Agriculture. the last census for which township data were readily available. The sampling area included all counties except Oakland and (Wayne lying south of a line running east from Lake Michigan. along the north sides of Oceana. Newaygo. Mecosta. Isabella. Midland. Bay. and Huron counties. Oakland and Wayne counties were excluded to avoid sampling from the Detroit and surrounding metropolitan areas. The 150W1’18hips selected were Niles and Sodus in Berrien county... Eaton Rapids in Baton county. North Shade in Gratiot county. Allen and Wheatland in Hillsdale county. Sebewa in Ionia cmlhty. Greenwood in St. Clair county. Elkland in Tuscola county and Arlington in Van Buren county. Following the 8election of these townships. the cooperative extension offices for the eight counties involved were asked to provide ¥ Mi , lcaloulated from: K.T. Wright and D.A. Caul. W. Extension Bulletin 582 (East Lansing: A chi-gar: State University. Cooperative Extension Service. “gust 1967). he a l: spe< add: the lis lis sun 121 aail hatt sat; acct 59 the name of a contact within each township whom they thought would be willing to provide a list of potential interview respondents. In eight out of the ten townships. township supervisors were recommended and in the other two townships. older farmers known to be familiar with most residents in their townships were used. These 10 contacts within each township were then visited in person and asked to prepare a list of about 12 to 15 people who would meet our population specifications. They were asked to provide the name. mailing address. telephone number and. for those still residing in the township. the plat map location. for each person on the list. They were each given up to ten days to prepare their lists and send them into the Department. Ten potential survey respondents were selected randomly from each list of 12 to 15 persons. In order to increase the response rate. a letter was mailed to each proSpective survey respondent explaining the nature of the study and requesting his cooperation. A sample copy of this letter is shown in the Appendix. The ten potential respondents from each township accounted for about 36 percent of the average total number 01' age 60 and over farmers in the sampling area. There Were 1.530 farms in the 10 townships in 1959. Assuming that there was a 30 percent decline in the number of farms Over the period 1959 to 1969 and that 25 percent of the farm operators are age 60 or over. the total number of I:’°"Iol'ltial respondents in 1969 would have been approximately 268. 6O Questionnaire Design The questionnaire used to interview the survey respondents was designed to obtain fairly detailed infor- mation on the following variables. 1. 2. 3. 4. 5. 6. Biographic information (a) Age. marital status. family size. etc. (b) Education (c) Farm and nonfarm employment history Financial and nonfinancial retirement goals (a) Satisfactory and minimum income levels .(b) Work and leisure activities (c)' Family considerations Financial position (a) Sources and amounts of income during 1968 (b) Living costs during 1968 (c) Present net worth Estate management programs Opinions on investment alternatives Actual or prOposed retirement programs A copy of the questionnaire is shown in the Appendix. Gaeations designed for all respondents were printed on white Paper. Yellow paper was used for questions 10 to 13 for I‘etzimed respondents and green paper was used for questions 1"" to 17 for those who were still farming. The color coding ‘Df"the questionnaire was used to help the interviewer locate the correct'sections. and it may have helped to maintain the resPondent's interest in the interview. Wherever possible. qua: tor att rea ti: 61 questions concerning very personal information such as net worth were placed near the end of the questionnaire. An attempt was made to alternate more difficult questions with easier questions to increase the chances of obtaining complete answers to all questions. For those questions which required an ordering of the respondent's preferences. a list of all permissible responses was presented by the interviewer on a small card. Two major drafts of the questionnaire were tested before the final version was selected. The first draft was pretested on four people whose names were provided by a County Extension Director. A second draft was used in one of the townships included in the study. It was possible to use the data from the second pretest because only minor changes were incorporated into the third version of the questionnaire. An Evaluation of the Survey Procedure The sampling procedure was designed to obtain a reasonably random selection of elderly farmers and retired farmers at the minimum possible cost. One alternative procedure would have been to have the county extension per- sonnel submit lists. but this method was rejected because of the probable bias toward the more outgoing type of farm operator presumed to be served by the extension service.' Another alternative which was considered was to call on all farms within the sample townships. but this method was +3- 94. 62 rejected because of the high costs involved. Only about one farm residence out of five would have yielded an eligible reapondent. and it would have been impossible to write to them in advance of the interview. The procedure did result in one fairly serious source of bias. The contacts were more likely to provide the names of persons still residing on their farms than of people who had retired and moved away from the community. An attempt was made to avoid this problem by specifically asking the contacts to include the names of some people who had moved out of the townships upon retiring but most of them indicated that very few. if any. people had retired in this manner. ‘ The survey-began with a potential list of 100 respondents. One of the township contacts failed to send in a list of names. leaving a potential sample size of 90. {Phe breakdown of these 90 possible interviews was as shown in Table III-l. There were two main difficulties with the question- naire. First. information on income and living costs was dependent upon the recall ability of the reSpondent. Very few respondents had records which they could consult. and often they were unable to provide estimates. For example. the reSpondents frequently did not know the amount of their household grocery expenditures. For this reason. the inter- viewer was instructed to have both the husband and wife present during the interview if at all possible. A second source of difficulty was the reluctance of some respondents fin»fi£mu£30.b \nb DECORGQK >.0>.H3.mu thumc :c*u~r:F-Ffic.hx. 63 r—lOr-ie-le-{OOONO r-I NNONHHNNHM OOOONOOOON O\ H HHOWNNMNN O m ‘\o o. O\ .4 .s o- V1 «3 In Awpmnoooooca mmuamssowpmosa ransom: .a«:mssoa meanmssoe an owsoamom ho>nsm mo newsmasnme::.H:HHH canoe 64 to divulge information on income. net worth. and other personal information. The problem of nonreSponse was not unique to this particular study although it was believed more serious than usual because of the particular age group being interviewed. No attempt was made to estimate the nonresponse error. but it was observed that the incidence of nonreSponse was probably higher among the wealthier 2 This tendency would result in underestimates respondents. of the true means of income. asset and debt variables. Incomplete questionnaires were normally excluded from the final tabulation of the results. In a few cases. questionnaires which were complete except for one or two items were used. Fifty questionnaires were selected for analysis. Forty-three people provided complete net worth statements. 40 gave complete income statements. and 36 questionnaires contained complete estimates of total annual living costs. Suggestions for Future Surveys The comparatively low response rate in the survey can be partially attributed to certain procedures which were used to minimize interviewing expenses. Nevertheless. it was possible to obtain detailed financial and personal infor- mation from a sample of elderly farm people who. as a group. are known to be generally reluctant to participate in surveys. 2For a discussion of this problem. see Projector and Weiss. Survgy 9f Einangial Characterisrics of Consumers. pp. 58- l. 65 The letter which was mailed in advance of the inter- view was extremely useful in achieving good rapport between the interviewer and the respondents. The use of such a letter is recommended for future surveys of this type. Local contacts such as township supervisors are also very helpful when a subset of the farm p0pulation is being studied. The contacts used in this study were generally very cooperative in providing lists of names according to the specified criteria. The availability of names. addresses. telephone numbers. and plat map locations for most of the prOSpective respondents resulted in a considerable reduction in interviewing expenses. Summary A brief description of the survey procedure was given in this chapter. Some of the advantages and disadvantages of the sampling procedure. the questionnaire design and the interviewing procedure were pointed out. These aspects of the survey will be elaborated on in the presentation of the results which follows. CHAPTER IV DESCRIPTIVE ANALYSIS OF THE DISINVESTMENT PROBLEM The data which were collected in the survey of farmers and retired farmers from across Michigan are presented in this chapter. The survey was designed to obtain information on four major areas: (1) backgrounds. (2) retirement goals. (3) financial situations. and (4) attitudes toward invest- ment alternatives. These kinds of information were collected to determine the personal and financial constraints which would influence retirement programs for farmers. Biographic Information Egrsonal and family backgrounds The frequency distributions for age and family size are given in Tables IV-l and IV-2. Forty-two of the reSpondents were married. five were predeceased by their wives and three had never married. Only two of the respon- dents still had children living at home who were dependent upon them for financial support. Ten of the respondents had a son or son-in-law who was engaged in full- or part-time farming. Educatign and emplgyrent history Table IV-3 shows the frequency distributions of the number of years of formal education attained by the survey 66 67 Table IV-l.--Frequency Distributions of Ages Age Resgondents nges Number Percentage Number Percentage Under 64 0 O 12 28.5 70 to 74 11 22.0 10 23.8 75 to 79 13 26.0 9 21.4 80 and over 6 12.0 2 4.8 No reSponse _Q 0.0 2 4.8 50 100.0 HE 100.0 Median 71 70 Mean 72.1 67.1 Range 64-8 57-8 Table IV-2.--Frequency Distribution of Number of Children Number of Children Number Percentage 0 9 19.2 1 9 19.2 2 11 23.2 3 8 17.1 4 3 6.4 5 or more I:1 14.9 Total 7 100.0 Median 2.0 Mean 2.4 Range 0-8 68 respondents. The average respondent had received over nine years of formal education. Nearly one-quarter had received some additional training. such as agricultural extension courses. business school. welding. mechanics. etc. Table IV-3.--Frequency Distribution of Years of Formal Education Years of Education Number Percentage Less than 8 6 12.0 8 20 40.0 9 to 12 18 36.0 13 or more _6 12.0 Total 50 100.0 Median 8 Years Mean 9.3 Years Range 3-16 Years Nearly all of the respondents were born and raised on farms. Table IV-4 contains the frequency distribution of the years in which they started farming on their own. In addition to their lifetime experience in farming. nearly 60 percent of the respondents had worked at a nonfarm job at some time during their careers. Table IV-5 shows the number of years of nonfarm employment. Those who had worked in a nonfarm occupation were employed at a regular. though not necessarily full time job for an average of 13 years. On the date of the interview 21 of the 50 respondents were completely retired from farming. 16 were partly retired. 69 Table IV-4.--Frequency Distribution of Year ReSpondents Started Farming W Year Number Percentage Before 1920 14 28.0 1920 to 1929 21 42.0 After 1929 14 28.0 No ReSponse _l ' 2.0 Total 0 100.0 Median 1926 Mean 1924 Range 1907 to 1945 Table IVo5.--Frequency Distribution of Years of Nonfarm Work Number of Years Number Percentage 0 21 42.0 1 to 4 5 10.0 5 to 9 6 12.0 10 to 14 6 12.0 20 or more _8_ 16.0 Total 50 100.0 Median 205 Mean 7.? Range 0-43 D) h _, __._ 70 and 13 considered themselves to be full-time farmers. About half of the retired respondents had left farming within the preceding five years. All respondents were asked about the type and size of farm which they were operating or had operated prior to retirement. The data in Table IV-6 suggest that the farms being operated by the respondents who were still engaged in farming were smaller. in terms of both tillable and total acreage. than were the farms formerly operated by the retired respondents. However. the gross farm income data in Table IV-7 suggest that the respondents who were still farming received a higher average gross income over the three years immediately preceding the survey than did the retired respondents during their last three years in farming. The differences in farm sizes and gross income can be partially attributed to the different time periods over which these variables were measured. Price level changes and the fact that the retired respondents often could not accurately recall the income data would account for some of the differences. Another factor may be that farm income typically decreases as the farmer gets older and probably reaches its lowest level in the years immediately preceding the complete with- drawal from active farming. The principal enterprise data in Table IV-8 suggest that many older farmers withdraw from labor-intensive enter- prises such as dairying. Dairying had once been the prin- cipal enterprise of one-third of the 21 retired respondents: 71 OHN-nN mNNuos sHm-mm sHm-sm omens m.ee m.sHH e.oNH o.msH zoos 0.6m o.oHH o.OHH smH ssHoos 0.00H mm o.ooH mm c.00H Hm o.OOH mm Hopoe o o o o de:: N WJMII N oncoammm oz 6 o o o m.m N m.o N shoe no oom m.m H n.0H m m.: H m.o N omN op OON m.e N N.sH m m.a N H.oH s ooH op omH n.0H m m.mH s m.sH m m.sH m 02H op mNH n.0N e n.0H m m.m N m.o N sNH op OOH m.ss mH H.nm HH e.mN a H.mH s as op on m.mH s n.0H m n.sH n m.o N on soap nmoH .pCooumm .oz .pSoouom .oz .psoonom .oz .psoouom .oz mouo< :mmmmmmalmmmma_ mmmmmm«IMHmmmde _nmmmmmmmlflmmmw No mpQQWQNNMMMIdMHNHMMIIIII. nonssz oopmuoao pmwn Sham Mo ouHm so soapannpmHQ hosesuohm::.m:>H wands 72 Table IV-7.--Frequency Distributions of Gross Farm Income Retired ReSpondents- Respondents Still Average Over Last Farming - Average 3 Years of Active Over Last 3 Years Farming Gross Income Number Percentage Number Percentage Less than $1.000 O 0.0 l 3.5 $1,000 - 1,999 2 9.5 2 7.0 2,000 - 2,999 2 905 6 2006 3.000 - 3,999 O 0.0 2 7.0 4,000 - 4.999 1 4.8 0 0.0 5.000 - 7.499 3 14.3 5 17.2 7.500 - 9.999 3 14.3 4 13.8 $10,000 or more 1 4.8 6 20.6 No Response _9 42.8 _3_ 10.3 Total 21 100.0 29 100.0 Median $5,000 $5,000 Mean $5,058 $6,086 Range $1.000-$10,000 $600-$18,000 Table IV-8.--Frequency Distribution of Type of Farming Principal Enterprise Principal Enter- of Retired Respon- prises of ReSpon- dents Before dents Still Retirement Farming Enterprise Number Percentage Number Percentage Dairy 7 33.3 4 13.8 Beef and/or Hogs 0 0.0 6 20.6 Poultry 0 0.0 O 0.0 Cash Crop 10 47.6 10 34.5 Fruit 2 9.5 5 17.3 Other 1 4.8 2 6.9 Not Reported _; 4.8 2 __§r2 Total 21 100.0 29 100.0 73 however. only about 14 percent of the reSpondents still in farming had dairying as their principal enterprise. Conver- sations with the respondents confirmed that many had discon- tinued livestock enterprises and had gone to cash crop programs which could be operated by hired labor and custom hiring of machinery services. Retirement Goals The first four questions in the questionnaire were designed to find out what older farm people consider to be a satisfactory retirement situation in the absence of any Specific financial or other restrictions which would prevent them from actually achieving this situation. This attempt to define retirement goals was only partially successful because many of the reSpondents did not seem to detach themselves Sufficiently from the reality of their own situations to consider alternatives. An attempt was made to force them to c=<>1'1s:ider other alternatives by asking them to give their first, second. and third choices: however. very few actually gave more than one or two choices. mmoda i locati n The summary of the responses to the question on locational preferences during retirement shown in Table IV-9 indicates that a majority of the older farmers apparently prefer to remain on their farms during their retirement years. All 50 respondents provided a first choice of retire- m .9111; locations and 76 percent said they preferred to live on 74 a farm. About half of the reSpondents who gave a second choice indicated that living in the country but not on a farm would be fairly consistent with a satisfactory retire- ment situation. Living in an urban location such as a city or even a village or small town is apparently inconsistent with the retirement goals of most older farmers. Table IV-9.--Frequency Distribution of Locational Preferences (Percentages) “W Village or On Rural Small Farm Nonfarm Town City Other No Answer First Choice 76.0 12.0 6.0 2.0 4.0 0.0 Second Choice 4.0 30.0 22.0 2.0 4.0 38.0 Third Choice 0.0 6.0 10.0 2.0 0.0 82.0 _—* The data in Tables IV-lO and IV-ll reveal two other Strong environmental preferences among older farmers. Eighty- eight percent of the reSpondents wished to remain within 25 miles of their present location during retirement. This Preference suggests that factors such as community ties. and Perhaps living near friends and relatives are important to most older farm people. The few who preferred some other location outside of Michigan usually mentioned that they hoped to retire in a warmer climate. The fact that virtually all Of the respondents wanted to live in their own houses (1 uring retirement suggests that a feeling of independence is 75 important. However. half of the 22 reapondents who gave a second choice indicated that a mobile home. a comparatively low—cost housing alternative, would also be satisfactory. Table IV-lO.--Frequency Distribution of Geographical Preferences During Retirement (Percentages) m Within 25 Miles Another Location of Present Location in Michigan Other 88.0 6.0 6.0 Table IV-ll.--Frequency Distribution of Housing Preferences During Retirement (Percentages) Own Rented Apart- Mobile Nursing No House House ment Home Home Answer FirSt ChOice 9600 000 000 “'00 000 0.0 Second Choice 0.0 6.0 10.0 22.0 6.0 56.0 Third ChOice 0.0 4.0 200 200 200 9000 W k ' v 'es All respondents were asked how they would occupy their time if they were to have a satisfactory retirement situation. A 8“Prong desire on the part of older farmers to keep active is bOil'ne out by the data in Table IV-lz. Seventy-eight percent of the respondents expressed a desire to continue do ing some full- or part-time work during their retirement yeta-1‘8. Table IV-l3 shows the relative popularity of the ways 0 Occupying leisure time among the survey respondents. 76 Table IV-12.--Frequency Distribution of Preferences for Working During Retirement (Percentages) No Full Time Part Time Part Time to No Work for Income for Income Occupy Time Answer 18.0 12.0 36.0 30.0 4.0 Table IV-l3.--Preferences for Leisure Activities During Retirement W Number of Leisure Times Percentage Activity Mentioned of Sample Radio and Television 28 56.0 G ardening 24 48. 0 Hunting and Fishing 23 46.0 Reading 21 42.0 011113. Church Organizations 20 40.0 Traveling 19 38.0 V isitin Friends 13 26. 0 Sports Golfing, Bowling, etc.) 8 16.0 —H L e tirement incomg goals The final question on retirement goals asked for the aJflount of income needed to provide a satisfactory retirement Sithlation at today's conditions. The responses to this Question are tabulated in Table IV-l4. These responses must be interpreted within the context of their other retirement goa18. As a group, the reSpondents preferred to stay on their farms or in some other rural location where housing costs would be low. Also, they did not intend to pursue any pa‘r‘tlicularly eXpensive leisure activities during retirement. 77 Table IV-l4.--Frequency Distribution of Satisfactory Retirement Income Goals $- Annual Income Number Percentage Less than $2,500 5 10.0 $2,500 to 3.999 10 20.0 4,000 to 4,999 6 12.0 5,000 to 5:999 9 18.0 $6,000 or more 6 12.0 No Response _l_4_ 28.0 Total 50 100.0 Median $4,400 Mean $4,404 Range $1,2oo-$9.6oo In estimating their minimum retirement income needs, Which are shown in Table IV-lS, many reapondents based their estimate on the costs of housing on a farm or in some other rural location. Many also qualified their answer with the Condition that there be no major medical expenses. Table IV-l5.--Frequency Distribution of Minimum Retirement Income Requirements y y Annual Income Number Percentage F‘s-gas than $2,000 10 20.0 .000 to 2,999 8 16.0 3.000 to 3,999 11 22.0 Ore than $4,000 5 10-0 ° ReSponse lé _1_2.0 Total 50 100.0 Mean 2,829 Range $1.000-$5,000 \ 78 W _ For the majority of the survey reSpondents, the goal of keeping the farm business in the family did not seem to be important. Thirty-nine of the 50 respondents said they had not assisted a close family member: that is, a son or son-in-law, to become established in farming, and they did not expect to do so in the future. Nine reSpondents had provided assistance in the form of real estate or nonreal estate loans, free labor, gifts, use of machinery, or other kinds of assistance. Two reSpondents were uncertain as to whether they would be providing assistance in the future. Only 3 of the 21 retired respondents had transferred real estate to a close relative and only 4 of the 29 reapondents Still engaged in farming planned to transfer their farms to a relative upon retiring. Another four were uncertain regarding the transfer of their farms to a relative. Although the goal of transferring the farm to a relative during their lifetimes was not important to most respondents, their desire to keep their farms as long as Possible may indicate that they want to have the farm trans- ferred to their heirs at the time of death. Presumably, this goal Was not usually related to helping their heirs become es‘tablished in a farm business since only one-fifth of the I“‘3SI'->Ondents had close family members who were farming or who definitely intended to farm. 79 Summary of retirement goals This section has dealt with the retirement goals of all 50 survey respondents. Generally, older farm people would like to live on their farms and continue working there as long as possible. Seventeen of the 29 reSpondents who were still farming said that they did not plan to retire from farming, 7 planned to retire, and 5 were uncertain. Their health status appears to be the most important determinant of their retirement plans. Most elderly farm people want to live in their own houses, although mobile homes were a strong second choice. They also prefer to remain in the communities Where they had spent most of their lives and they would rather occupy their time by working than by pursuing leisure acti- vities. Finally, for most people, the transfer of the farm business to a family member or helping a family member become established in farming is not a particularly important go a1. Financial Situations With advancing age, most elderly people reduce their labor and management participation in both their farm and nonfarm occupations, and they become almost completely dependent upon social security benefits, pensions, and investment income in the form of rent, interest, and divi- dends from their accumulated assets. This section examines t . . . he financial situations of the survey reSpondents in terms 80 of their assets and liabilities, current amounts and sources of income, living costs, life insurance coverage, and estate transfer programs. WW There were several difficulties associated with obtaining financial information such as net worth, income, and living expenditures. As was pointed out previously, the wealthier reSpondents were more likely to refuse to take part in the survey, and those who did participate seemed to be more reluctant to divulge financial information. Estimates of the market values of some assets were difficult to obtain. Many people seemed to be unable to accurately estimate the market value of their farm real estate. In three cases, the mean value per acre provided by other reSpondents in the same township was used. Many reSpon- dents based their estimates on recent sales which had come to their attention or on prices being asked by acquaintances living in the area. Thus, there probably was a tendency to OVerestimate the real estate values. Most respondents were able to give what was thought to be a realistic estimate of the values of farm machinery. liveStock, and farm inventories: however, in general they were reluctant to give a detailed breakdown of liquid asset holdings. Generally, bank savings accounts, cash and checking accounts were recorded simply as ”bank accounts". Those who h eld common stocks, bonds and mutual funds would frequently 81 provide a lump sum estimate for these kinds of assets but they were reluctant to give a breakdown. These lump sum estimates were recorded as "unclassified liquid assets". It was also virtually impossible to obtain estimates of the cash surrender value of life insurance policies held by the 22 respondents who carried life insurance. The mean face value of the coverage of those who carried insurance was $1,714 and the median coverage was $1,500. Most of the policies were either ordinary life or limited pay life and most had been taken out during the 1930's or 1940's. A more complete discussion of their life insurance coverage is given later in this chapter. Most reSpondents understandably had some difficulty in estimating the market value of their personal possessions. Usually, they tended to place a realistic market value on automobiles, "trucks, mobile homes, etc., but items of house- held furniture were valued at replacement cost based on the amount of insurance coverage on household contents. The lower reSponse rate among wealthier persons and difficulties in categorizing and estimating the value of Certain kinds of assets probably resulted in a slight under- e‘z-‘l‘J-mate of the pOpulation means of the financial variables. The market value of farm real estate and personal possessions may have been overestimated, and generally, debts were probably understated: however, these latter factors would only pa'tially offset the general tendency to underestimate av erage net worths. No attempt was made to adjust the estimates 1‘0 r the suspected downward bias. 82 Net worth Table IV-16 shows the frequency distribution of the total net worths of the survey reSpondents. These total net worth figures are the sum of the estimated values of both productive assets such as farm real estate, and nonpro- ductive assets such as household furnishings minus the estimated amounts of all debts. Table IV-l6.--Frequency Distribution of Total Net Worth Frequency Net Worth Number Percentage Less than $20,000 3 6.0 $20,000 to 29,999 3 6.0 30,000 to 39.999 7 14.0 40,000 to 49,999 6 12.0 50,000 to 59,999 9 18.0 60,000 to 74.999 7 14.0 75,000 to 99.999 4 8.0 $100,000 and over 3 6.0 NO Response _8 16.0 Total 50 100.0 Median 52,150 Mean 57,220 Range $10,500 - $166,850 Table IV-l? shows the average or composite balance sheet of the survey respondents and it indicates the relative f r eQuency with which the balance sheet items appeared in the net worth statements of the individual respondents. Some incomplete net worth statements were used to calculate the average amounts of the individual items in the composite 83 r1:‘a.ble IV-l7.--Average Composite Balance Sheet of the Survey ReSpondentsa _— I r— it Average Percentage Reporting Amount Item Assets Cash 33 130 12.0 Unclassified Liquid Assetsb 2,820 20.0 Bank Accounts 4,850 50.0 Bonds 120 2.0 Common Stocks, Mutual Fund Shares 1,390 14.0 Livestock 950 30.0 Farm Machinery 3,500 70.0 Feed, Crops, Supplies « on Hand 170 20.0 Land Contracts 2,880 18.0 Personal Possessions 3,360 100.0 Nonfarm Dwelling 2,290 10.0 other Nonfarm Real Estate 3 610 10.0 Farm Real Estate 36,200 84.0 Total Assets $59,770 100.0 Liabilities Accounts Payable 50 6.0 Installment Debt 60 4.0 Sl‘iort-term Notes 350 8.0 Real Estate Debt 850 14.0 Total Debt $ 1,310 20.0 Owner Equity 58,460 I 100.0 Total Liabilities $59,770 100.0 b 8'Calculated from the mean values of the individual viilamce sheet items on all survey respondents who pro- ded complete or partial net worth statements. re bSeveral reapondents were unwilling or unable to buport their liquid asset holdings by separate categories, if‘ did provide an estimate of total liquid assets. Unclass- oled liquid assets include cash, bank accounts, bonds, minor: stock,‘mutua1 fund shares, and personal loans. 84 balance sheet: thus, the net worth estimates in Tables IV-l6 and IV-l? do not agree exactly because of the differences in sample sizes. The average survey respondent has reached retirement age with a net worth of slightly less than $60,000. The composite balance sheet and the frequency with which the individual asset and debt items were reported reflect some of the more important personal and financial goals of the older farmers. Most reSpondents still owned their farm real estate and they did not intend to liquidate it unless abolutely necessary. Eighty-four percent of the reSpondents still owned farm real estate and it represented over 60 percent 025' their total assets. Other farm assets made up only about 8 percent of their total assets. Bank savings accounts were also a fairly common balance sheet item among the survey Pe Spondents. Fifty percent reported having bank accounts Whereas only 16 percent held common stocks, mutual funds and/or bonds. The relative frequency of holdings of bank accounts, common stocks, mutual funds and bonds would ac tually be somewhat higher than indicated if the exact composition of the "unclassified liquid assets" category was knc>Wn. Only 10 percent owned a nonfarm dwelling, and this finding is also consistent with their desire to remain on the farm. A debt free financial status was a source of pride for most of the survey reSpondents. The mean debt load for 85 all reSpondents was only about $1,300, but among those individuals who did have debts, the average amount was approximately $6,100. Sources and amounts oLincome The average net income in 1968 for the 40 reSpondents who answered the income section of the questionnaire was $4,300. The frequency distribution of the amounts of income for 1968 is shown in Table IV-18. A composite mean net income statement is shown in Table IV-l9. Social Security benefits were the most important source of income in terms of both the average amount received and the fre- C11.1ency with which they were reported. Farm business income aSkid/or farm rental income were also important sources of income for many reSpondents. Over half of the reSpondents received some nonfarm investment income in the form of interest and dividends, but this source accounted for only 13 percent of the total income of the average survey respondent. The median net cash income for the sample members last year was only $3,584. This median is probably a better Overall reflection of the income status of the survey re Spondents than the mean because 40 percent of those reSpon- ding received an income of less than $3,000 in 1968. The composite income statement in Table IV-l9 and the composite balance sheet in Table IV-l? together provide 8‘11 approximate estimate of the rate of return on the different kiI'ids of assets held by the survey reSpondents. Net farm 86 Table IV-18.--Frequency Distribution of Net Cash Income, 1968 Net Income Number - Percentage Less than $2,000 7 14.0 $2,000 to 2,999 10 20.0 3,000 to 3,999 5 10.0 4,000 to 4,999 5 10.0 5,000 to 59999 5 1000 6,000 to 8.999 6 1200 $9 , 000 or more 2 4.0 Tic) ReSponse 12 20.0 Total 50 100.0 Median 3:584 Mean 4,300 Range $840-$14,280 Table IV-l9.--Av2rage Composite Net Cash Income Statement, 19 8 W Mean Amount (Dollars per Year, Percentage Including Reporting Source Income to Spouse) Item Farm Rental Income $ 540 20.0 arm Business Income 829 34.0 £iJLary and Wages 775 16.0 I'l‘terest and Dividends 561 52.0 Sc><3ia1 Security Benefits 1,423 76.0 Peahsions 144 8.0 weIlfare 28 2.0 Total Income $4,300 \ 87 income and net rental income from farm real estate amounted to $1, 369 for the average sample member. From Table IV-l7, the average sample member had $36,700 invested in farm real estate, $3,500 in farm machinery, $950 in livestock and $170 in farm inventories, for a total investment of $41,320 in farm assets. Even if no charge is deducted for labor and management, the average rate of return on farm assets was only 3.3 percent in 1968. The average sample member received $561 in nonfarm investment income and his investments were: bank accounts, $4,850: bonds, $1203 common stocks and mutual funds, $1,390; land contracts, $2,880; other nonfarm real estate, $610: and unclassified liquid assets, $2,820. The total average investment in nonfarm securities and real Property was $12,670 and the $561 in nonfarm investment income represents an income rate of return of only 4.4 Percent. The overall mean rate of return on productive assets was 3.6 percent before income taxes. A yield of only 3.6 percent on productive assets suggests that if retirement age farm people were to liqui- date all of their assets except their personal possessions and nonfarm dwellings and invest the proceeds in even the more conservative alternatives such as insured savings and loan associations or bank savings accounts, they could iImprove their incomes substantially. However, there are Se"eral factors which suggest that the true rate of return was higher than 3.6 percent.. First, if they were to liqui- date their assets, the people now living in their farm homes 88 would have to obtain alternative housing. The purchase or rental of alternative housing would reduce the amount of funds which could be invested. Another factor which would reduce the amount which could be invested is the capital gains tax. The difference between the purchase price and the selling price of the real estate would be taxed at half the rate at which regular income is taxed during the year of sale. The only exception is where the farm is sold on a land contract with a down payment of 30 percent or less. Most of the survey respondents started farming before 1930; thus, the capital gains tax might be substantial for some Of these pe0ple. A third factor which suggests that the current rate of return on assets is more than 3.6 percent was an apparent tendency for the survey respondents to over- estimate the market value of their real estate. Finally, the 3'6 Percent rate of return does not include the annual appreciation on real estate and equity securities such as °°mm°n stocks and mutual funds. A more detailed analysis °f Whether the retiring farmer should retain his farm assets or liquidate them is deferred to the later chapters. \Livihg costs All survey respondents were asked to provide a deta~iled statement of their family living expenditures for 1968. Only 36 of the 50 reSpondents were able to provide a complete estimate of total living eXpenses while others col“Dileted sections of the living cost part of the question- 1‘1 a’il‘e. Most of the incomplete statements were caused by the 89 inability of the respondents to estimate their weekly, monthly, or yearly exPenditures for food, beverages, and other grocery items. These partial statements were included for the purpose of computing a composite statement of house- hold eXpenditures. The mean total amount of family living eXpenditures for the survey members in 1968 was $3,364 and the median amount was $3,276 as shown in Table IV-20. About 45 percent of the reapondents who reported their living costs had spent between $3,000 and $3,999 in 1968. Table IV-20.-.--Frequency Distribution of Total Living Costs, 1968 n —_ Living Costs Number Percentage Less than $2,000 4 8-0 $2.000 to 2.999 7 14.0 3: 000 to 3.499 9 18-0 3.500 to ,999 7 14.0 4.ooo to .999 6 12.0 $5,000 or more 3 6.0 NO Response .13. 28'0 Total 50 100.0 Median 39276 Mean 3036i+ Range $1.205-$6:580 \ The breakdown of their living eXpenses by major category is shown in the composite statement of living costs in Table IV-Zl. The total eXpenditures data in Table IV-ZO and the items in the composite statement in Table IV-Zl are based on different sample sizes; hence, there is a discre- barley in the estimates. 45.2; 90 Table IV-21.--Average Composite Living Costs Statement, 1968 H Mean Housing (Rent Payments, Mortgage Payments, Property Taxes on Nonfarm Residence Onl ,a Utilities, Maintenance and Fire Insurance) 691 Medical Care (Medical Insurance Premiums, Doctor and HosPital Care, Dental, Drugs, Eyeglasses) 380 TranSportation (Estimated Auto Expensesb and Fares for Bus, Train, Plane, Taxi, etc.) 728 Miscellaneous (Clothing, Recreation, Gifts and Charity, Reading Material, and Income Taxes) 638 Other Living EXpenses 36 Total $39513 . 3The amount of property taxes paid in 1968 was ob- taimed from each respondent but if he still owned farmland and was either renting it out or farming it, property taxes were regarded as a business expense instead of a living cost. bIn view of the obvious difficulties in obtaining eatiIllates of the actual costs of automobile ownership, the qu9.,3“l=:’l.onnaire requested information which could be used to estil-“flats these costs. All respondents were asked to give the :11an mile e driven and the make, model, and age of their entomobilds . The fixed and variable costs of owning and Lli’erating an automobile were obtained from Cope, E.M. and D 313011, L.L., Cost of Operating an Automobilg (Washington, Adm. 3 U.S. Department of Transportation, Federal Highway in inistration, November 1968), p. 9. Adjustments were made o garaging, parking, tolls and insurance premiums to reflect ognership costs in rural Michigan instead of the urban area c e which this study was based. A variable cost of 4 3/4 192*:8 per mile plus an annual fixed cost of $350 for pre- Th 5 models and $375 for 1965 and newer models was used. the two different fixed cost estimates reflect the assumption what people do not normally carry collision insurance on cars 1c}, are more than 4 years old. 91 The major items in the reapondents' budgets were food, housing, and tranSportation costs. The rural location of most reapondents probably results in their having lower housing costs and higher transportation costs compared to their urban counterparts. Expenditures for medical care were a source of great concern for all respondents. Most of the respondents and their wives were covered by medicare which is paid for through a $4 monthly deduction from their social security income. Forty-six of the 50 respondents were covered by medicare and/or some other type of medical insurance. Nevertheless, about one-third of the respondents incurred medical expenses in 1968 which were not covered by insurance. The amounts involved ranged from $21 to $1,800. The cash flow data indicate that average total income ellcceeded average total living costs by approximately $940: however, as the data in Table IV-22 indicate, only about half or the reSpondents who completed both the income and living C=<>sts questions received enough income to cover their living expenditures in 1968. Those who did not have enough income W(Mild have needed an average of $945 additional income to cover their living costs. For those whose income was more than enough to c0ver living costs, incomes exceeded living costs by an average of $2,510. To supplement the income and expenditure data, the interviewer was asked to comment on each reSpondent's °b8erved level of living, quality of housing and furnishings, and other aspects of his situation. They were then rated as 92 ”very good”, ”good", ”fair”, or ”poor" depending upon the interviewer's remarks. These ratings are tabulated in Table IV-23. The majority of the reSpondents were rated as ”very good”, or ”good", but "fair” or ”poor” ratings were given to about one-quarter of the total. Most people appeared to have adequate food, shelter, clothing, and medical care, but expenditures for luxury items were kept to a minimum. Also, many people were not keeping their farm dwellings and service buildings in good repair presumably due to a lack of funds. Table IV-22.--Frequency Distribution of Income Minus Living Costs, 1968 1 (Income) - (Living Costs) Number Percentage ‘$2,000 or morea 1 3.7 -l.000 to 4,9993 5 18.6 ‘500 to -9993 3 11.1 0 to 4993 4 14.8 0 to 499 1 3.7 500 to 999b 3 11.1 1 . 000 to 2,000ID 4 14.8 $2.000 or more _6_ 22,2 Total 27 100.0 Median 318 Mean 846 Range -$2,030 to $6,861 aLiving costs exceeded living expenditures for 13 of the 27 respondents who provided complete statements of both. The mean deficiency was $94? the median was $729 and the I‘ange was from -$2,030 to - 249. l bFourteen reSpondents had incomes which exceeded iVing expenditures. The mean amount of excess income was $2. Zéoé6the median was $1,677 and the range was from $318 , 1. 93 Table IV-23.--Frequency Distribution of Respondents' General Situation - n:- —_— S i tuation Number Percentage Very Good 10 20 Good 26 52 Fair 8 16 Poor 4 8 N 0 Comments 2 4 All respondents were asked to give their own evalu- ation of their retirement income position. In answer to the question, ”Do you feel that you will have enough income throughout your retirement years, or do you expect to have financial problems?“, 2 said they would definitely not have enough retirement income, 11 expressed serious doubts about having enough, 17 thought they would probably get by, 8 Were confident that they would have enough income, and 12 were uncertain. These responses were open-ended and the c3<>ding of the answers was somewhat subjective, but they do e“-lggest that less than 20 percent of the respondents were completely satisfied with their retirement income prospects. Inflation, rising property taxes, and unexpected medical expenditures were the most frequently cited reasons for their concern about retirement income. \Life insurance and estatg L‘anggement proggams A comprehensive treatment of life insurance and estate pla-nning was beyond the scope of this study. However, since 94 retirement planning and estate management are closely inter- related a question was included in the questionnaire to examine the reSpondents' estate transfer and life insurance programs. An estate transfer plan serves two basic functions. First, it insures that assets are distributed among heirs in the desired manner. Secondly, it may reduce needless capital loss due to capital gains taxes, legal costs, inheri- tance taxes, mismanagement of assets, etc. The basis of any estate plan is a will. A will insures that the deceased person's property will be distributed according to his personal wishes instead of according to state laws of descent and distribution. A will is particularly important to protect the financial security of a surviving widow. Thus, all 2E‘ailrmers should probably have a will and, depending upon an il'ldividual's circumstances, other estate transfer devices SInch as life insurance, trusts, co-ownership, etc., may be useful. A11 50 reSpondents answered the section on estate 13I‘ansfer plans and their responses are shown in Table IV-24. 0I’L'Ly 32 percent indicated that they had already made a will. Thirty-four percent said they definitely planned to make a will and the remaining 34 percent had no intention of ever making a will. Fourteen percent held real property as joint tenants with heirs, and 14 percent said they had made gifts 91‘ sold property to heirs for the purpose of reducing estate 95 ‘bames. One respondent had established a trust fund, and two crthers were seriously contemplating the use of a trust arrangement of some kind. Tuable IV-Zh.--Estate Management Programs of Survey Respondents Frequency of Res onse (fiercentage Not Used Now Not Used Now But Will Be and Will Not Used Now Used Be Used Wills 32 34 34 Co -ownership-- joint tenants 1“ 2 8h partnership 2 O 98 corporation 0 O 100 other 2 0 98 G ifts 8 2 90 Sale 6 0 9h fllznust 2 n 9h ‘ As shown in Table IV-25, only about half of the respondents carried life insurance. The mean face value for 'tfuose who had coverage was about $1,700 and the most fre- ‘QJJent types were limited pay life and ordinary life. The aVerage policy was taken out about 19 years ago. Since most respondents were married, it is somewhat BuJr'prising that only one-third of them had made wills. The itlifrequent use of other estate plans is not as serious a 81'1 canes 130 real rate of return of “ percent. If capital losses upon liquidation reduced the value of his productive assets to $“0,000 he would need a net real rate of return of 5 percent in order to have a yearly income of $2,000: however, by gradually liquidating his $“0,000 portfolio over a 25 year period, he could spend $2,8“0 annually in addition to his social security benefits and other pension income. Summary Capital losses in the form of taxes, nonfarm housing costs and commissions for professional services favor retaining the farm assets following retirement. The higher rates of return and liquidity of nonfarm securities indicate that liquidation of the farm business would be the better alternative for many retiring farmers. This chapter has outlined general procedures for analyzing the basic retirement decision of retaining versus liquidating the farm business. The use of these procedures for retirement planning is illustrated for three cases from the survey in the next chapter. CHAPTER VI CASE STUDY ANALYSIS In this chapter the basic survey data from Chapter IV and the procedures for analyzing retirement decisions from Chapter V are combined to budget retirement income portfolios. These recommended portfolios were constructed on the basis of varying assumptions about financial posi— tions, financial and nonfinancial retirement goals, attitudes and abilities. To make the portfolios as realistic and meaningful as possible, actual cases from the survey were used. The basic retirement decision is whether or not to liquidate the farm real estate investment. Most of the survey reapondents wanted to keep their farms and either continue farming themselves or rent the land to a tenant. Some had sold their farms, either because they were forced to do so due to ill health or because they preferred to sell out and retire in a small town or city. Apparently the most important considerations are the low costs and nonfinancial benefits associated with continuing to live in the farm dwelling. 131 132 Investment portfolios were designed for low, medium and high net worth situations under the following two alternatives: (1) Liquidate the entire farm business and either relocate in another residence or retain the farm dwelling. (2) Liquidate only the farm chattels and rent the land out to a tenant. The alternative of continuing to farm after reaching retirement age was not included. If a family member or other suitable partner is available, staying in farming is obviously a very desirable alternative: however, an analysis of the wide variety of possible family farm partnership arrangements was considered to be outside the scape of this study. Continuing to farm without the assistance of a younger partner is ruled out. The survey respondents who had selected this alternative were receiving very low finan- cial returns. Also, at some point, ill health or the death of the operator will force the retirement age farm couple to select one of the two alternatives listed above, or some combination of the two. Unless there are strong personal motives for continuing to farm, one of the two major alter- natives listed above should be selected extenuating circum- stances such as ill health occur. Selection of Cases for Portfolio Analysis The forty-three questionnaires which contained complete, net worth statements were divided into three approximately («‘19: 133 equal groups on the basis of net worth. The mean dollar amounts of the more important financial variables for each group are shown in Table VI-l. Table VI-l.--Average Financial Situations of Low, Medium, and High Net Worth Groups of Reapondents (Dollars) ‘ Low Medium High Net Worth Net Worth Net Worth ($0-$39.999) ($40-59.999) ($60.000 and Over) Net Worth $29,500 $51,300 $89,700 1968 Income 3,1“0 3,880 5,590 Annual Living Costs 2,800 3,800 3,580 Satisfactory Income Goal 3,820 “,““0 5,170 Minimum Income Goal 2,500 2,730 3,060 Expected Social Security ' Income $ 1.750a $ 1.530a $ 1.7908 aIn December 1969, social security benefits were increased by 15 percent over the amounts shown. One questionnaire was selected from each group. These three cases are reasonably typical of their respective groups and their questionnaires were reasonably complete. The low net worth, medium net worth and high net worth cases were identified as LNW, MNW and HNW, respectively. 13“ Assumed Rates of Return for Early 1970 The expected rates of return used in the case study analysis are based on the economic conditions prevailing in early 1970. Historically high interest rates, depressed prices of nonfarm equities, and indications of a slower rate of growth in farm real estate prices all justify some deviation from the 1955 to 1968 results. In early 1970 new issues of corporate bonds currently were yielding between 8 and 9 percent. Yields on government bonds were generally 1 to 1 1/2 percent lower, depending upon the maturity dates. An expected net yield of 8 percent after paying brokerage commissions was assumed for the fixed- income assets in the budgeted portfolios. Farmers selling their farms on land contracts or mortgages should receive a higher rate of return to offset the obvious disadvantages of these securities compared to bonds. It was assumed that there would be no appreciable price returns from bonds. A total rate of return of 10 percent was assumed for nonfarm equity securities and this consists of “ percent income returns and 6 percent price returns. The total rate of return on nonfarm equities must be adjusted for brokerage commissions and other management expenses. A charge of 1 percent was assumed, giving net total returns of 9 percent for nonfarm equities. Over the 1953 to 1968 period, both the utility and industrial stocks would have provided total returns of more than 10 percent. Even the relatively 135 conservative income funds provided average total returns of nearly 10 percent. Since nonfarm equities can be easily liquidated, the exact break down between price returns and income returns is not of major importance. The outlook for the price and income returns from farmland as of early 1970 was somewhat uncertain and these returns vary widely depending upon the individual's situ- ation. Prices of farms located near urban areas usually ‘ increase at an above average rate: however, during 1969 the average price of farmland in Michigan remained virtually unchanged.1 There were indications that the rate of increase in farmland prices would be less than it was over the period 1955 to 1968. Income returns depend largely on the type of lease used and on the terms and conditions of the lease. Based on the survey results and the historical performance, it was assumed that an equitable lease arrangement would provide an annual income return of 3.5 percent. Price returns were assumed to be 3 percent per annum.2 The difficulty in converting price returns to conventional income returns is an important consideration in the case of farm real estate. lRichard Benson, "Money Likely to Remain Tight,” Michi Farm Economics, No. 323, Department of Agricultural Economics, Michigan State University, Co-operative Extension Service (December 1969), 2. 2See J.R. Brake, "Impact of Capital Structure on Capital and Credit Needs," f F mics, Vol. “8, No. 5 (December, 198%), 15%0. 136 The price returns, income returns, and total returns used to budget the retirement portfolios are shown in Table VI-2e Table VI-2.--Assumed Rates of Return for Investment Alternatives--Early 1970 (Percentages) Price Income Total Returns Returns Returns Fixed-Income Securities 0.0 8.0 8.0 Nonfarm Equity Securities 5.0 “.0 9.0 Farm Real Estate 3.0 3.5 6.5 Low Net Worth Case B ck u fo ati LNW is 67 years old and his wife is 63. They have one son who is a part-time farmer. LNW started farming on his own in the mid 1920's. He has held a regular part-time job throughout his farming career. LNW is now partly retired from farming as a result of a serious illness in 1968. Prior to this time he raised beef feeder cattle. He owns 80 acres, 50 of which are tillable and up until 1969, he rented an additional 60 acres of cropland. I Both LNW and his wife want to remain on their farm, but they said that some other alternative may be necessary, depending on LNW's health. They said that $5,000 per year 137 would be a satisfactory retirement income and that they would require a minimum of $3,500. Fipgpcigl position LNW has an estimated net worth of $32,350 which is slightly above the average for his group. His balance sheet is shown in Table VI-3. Table VI-3.--Low Net Worth Case Balance Sheet Aééfiié Cash and Savings Accounts $ “.000 Farm Inventories 350 Farm Machinery 1,000 Personal Possessions 3,000 Farm Real Estate 25,000 Total Assets $33.350 Militias Accounts Payable $ 500 Installment Debt 500 Owner Equity 32,350 Total Liabilities $33,350 An accurate estimate of LNW's 1968 income could not be obtained because all livestock inventories were liquidated. due to his illness and he also had to give up his part-time employment. He did estimate that under their plan to get back into farming, he would be receiving a net farm income of $3,000 per year and social security benefits and pension income of $2,“00 per year. LNW's social security benefits with the recent 15 percent increase would be $2,760 per year. 138 LNW's annual living costs are shown in Table VI-“. According to the interviewer's observations, LNW and his wife were enjoying a modest but adequate level of living. Table VI-“.--Annual Living Costs for the Low Net Worth Case Food $ 62“ Housing 750 Medical Expenses “11 Transportation 830 Miscellaneous ___“;Q Total Annual Living Costs $3,025 B e te v s Liquidate the entire farm business It is obvious that LNW and others in his net worth group should select the least expensive retirement housing alternative. This would be the mobile home or retaining the farm dwelling when the farm is sold, either of which, by assumption would reduce the value of earning assets by $6,000. Table VI-5 summarizes the capital losses for the low net worth case. LNW would incur capital losses of $9,167 if he were to liquidate his farm business. This represents a capital loss rate of 31 percent of the net value of his productive assets prior to liquidation. JI.|..| H. 139 Table VI-5.--Estimated Capital Losses for the Low Net Worth Case Total Value of Assets Before Liquidation $33,350 Less: Personal Possessions $3,000 Debt Repayment 1,000 -“,000 Value of Productive Assets Before Liquidation $29,350 Capital Losses Commissions for Realtor and Auctioneer (5% of $26,350 in Farm Assets) 1,318 Estimated Capital Gains Tax 1,6“5 Low Cost Retirement Housing 6,000 -8.263 Value of Productive Assets Following Liquidation $20,387 Commissions for Purchase of Nonfarm Securities (1% of the Value of Productive Assets) $ 20“ - 20“ Value of Investment Portfolio $20,183 Liquidation of the farm business and the purchase of a low cost form of retirement housing would leave LNW with about $20,000 for an investment portfolio. Assuming that they require a minimum annual retirement income of $3,500, this investment portfolio must provide net returns after inflation of at least $7“0. This amount represents a not rate of return of 3.7 percent: thus, at the assumed rate of inflation of 3 percent, the portfolio must provide total returns of at least 6.7 percent. The choice between equities and fixed-income securi- ties depends largely on.LNW's preferences for returns and risk. Since both he and his wife are comparatively young, the portfolio should contain a reasonably high proportion of equities to protect their assets and income from purchasing power losses. l“0 A $20,000 portfolio consisting of $12,000 in nonfarm equities, $6,000 in bonds and a $2,000 cash reserve would exceed their minimum income requirements. This distribution among the investment alternatives is recommended because the expected price returns of 5 percent on the equities would be sufficient to protect the whole portfolio against infla- tionary losses of 3 percent per annum. The price, income and total returns for this portfolio are shown in Table VI-6. Table VI-6.--Estimated Annual Returns from the Recommended $20,000 Investment Portfolio (Dollars) Amount Price Income Total Type of Asset Invested Returns Returns Returns Nonfarm Equities 12,000 600 “80 1,080 Bonds 6,000 0 “80 “80 Cash Reserve 2,000 __9 80 80 Totals 20,000 600 1,0“0 1,6“0 This portfolio yields a total rate of return of 8.2 percent before inflation or 5.2 percent after inflation. LNW could spend all of the income returns and be assured of a constant real income of $1,0“0 in addition to his social security benefits throughout his retirement years. Furthermore, the real value of his $20,000 worth of assets would remain constant. The social security income of $2,760 plus the $1,0“0 in investment income falls far short of LNW's goal of 1? .15.! .5, a l“1 $5,000 which he says they would need for a satisfactory retirement situation. Since all of the assets in the port- folio are highly liquid, LNW could supplement his social security and investment income by gradually liquidating his assets. Based on the net rate of return of 5.2 percent and the relationships between income and rate of return in Table V-7, LNW could Spend about $1,“25 annually by liqui- dating his portfolio over a period of 25 years. Under this alternative, his annual retirement income would be $“,185 annually. Given their life expectancy and the assumed rates of return, a $5,000 per year retirement income is simply not possible. Liquidate only the farm chattels and rent the land out LNW and his wife said they would prefer to keep their farm and rent it out if they were forced to discon- tinue farming themselves, so the rental alternative is consistent with their personal goals. Under this alternative, they would have $25,000 invested in farm real estate. The sale of their chattels would give them about $1,300, which, together with their $“,000 in savings would be available for debt repayment and a cash reserve. Their estimated retirement income with the rental alternative is shown in Table VI-7. The rental alternative provides a total rate of return of about 6.“ percent or 3.“ percent after inflation based on the $29,300 in productive assets. The 6.“ percent l“2 annual rate of return under the rental alternative provides a slightly higher eXpected income than does the 8.2 percent return after liquidation because of the 32 percent capital loss rate. Actually the break even rate of return needed to completely compensate for capital losses in 25 years would be nearly 11.0 percent and none of the investment alternatives provides break even returns giving the assumed rates of return in Table VI-2. Table VI-7.--Estimated Annual Returns with the Rental ‘ Alternative for the Low Net Worth Case (Dollars) Amount Price Income Total Type of Asset Invested Returns Returns Returns Farm Real Estate 25,000 750 875 1,625 Bonds 2,000 0 160 160 Cash Reserve 2,300 __Q ___33, ___22 Totals 29,300 750 1,127 1,877 Since farm real estate cannot easily be liquidated in small units, the maximum amount of spendable income under the rental alternative is $1,127, which together with the social security benefits would provide an estimated maximum annual retirement income of $3,887. Assuming that the farm is rented out on a share lease, the income return under this would be highly variable from year to year, as indicated by the historical pattern of income returns to farm real 1“3 estate. Also, the real value of these income returns would decline over time because of inflation. Summagy of the low npt worth case LNW could liquidate his farm business and either purchase a mobile home or keep the farm dwelling. Capital losses would reduce the net value of his productive assets fit to about $20,000 which could be invested in nonfarm securi- E ties. Given the expected rates of return assumed for early 1970 his annual retirement income under this alternative would be about $3,800 and this could be increased to a E5 maximum of nearly $“,200 by gradually liquidating the assets over a period of 25 years. The second alternative would be to retain the farm and rent it out. This alternative would provide a maximum annual retirement income of nearly $3,900. The main disadvantages of this alternative are the illiquidity of the farm real estate investment and the high variability of the income returns. . Both alternatives fulfill LNW's minimum retirement income requirements but neither enables him to achieve his satisfactory income goal of $5,000. The farm business liquidation alternative was budgeted using 8 percent returns for bonds and 9 percent returns for equities. By historical standards, the assumed bond yields are high. From the standpoint of eXpected retirement income, the rental alter- native would be superior if bond yields were only 5 or 6 percent per annum, as was the case until very recently. 1““ Medium Net Worth Case Backgpound information MNW is 79 years old and his wife is 75. Both MNW and his wife are in good health and they carry on a cash crop operation on their 80 acre farm. There apparently are no family members who wish to take over the farm business. MNW plans to continue farming indefinitely with the help of custom hiring and part-time hired labor. He stated that his net income from farming in 1968 was $“,OOO but that this was unusually high. He estimated that an annual income of $5,000 would provide a satisfactory retirement situation and that a minimum of $3,000 would be needed at today's conditions. Financial position MNW has total assets of $“8,500, consisting of $30,000 farm real estate, $5,000 in farm machinery, $11,000 in bank savings accounts and bonds and $2,500 in personal possessions. MNW is typical of the survey reapondents in that he has no debt. In addition to an estimated $“,000 in net farm income last year, MNW received $2,“50 in social security benefits and $“50 in investment income, for a total net income of $6,900. Their total living costs for a typical year are only $3,125, which is below the average for the medium net worth group. l“5 Budgeted altegpatives MNW is generally more fortunate than the Low Net Worth case because he has sufficient assets to provide an adequate level of retirement income. He also has an above average amount of social security income. Since he and his wife are older than the average survey respondent, they could also supplement their income by liquidating their I}: assets at a much faster rate. " L. Liquidate the entire farm business Table VI-8 shows the estimated capital losses that : MNW would incur if he liquidated his farm business. Table VI-8.--Estimated Capital Losses for the Medium Net Worth Case Total Value of Assets Before Liquidation $“8,500 Less Personal Possessions $2,500 -2,500 Value of Productive Assets Before Liquidation $“6,000 Capital Losses Commissions for Realtor and Auctioneer (5% of $35,000 in Farm Assets) 1,750 Estimated Capital Gains Tax 2,000 Low Cost Retirement Housing 6,000 -9.250 Value of Productive Assets Following Liquidation $36,250 Commissions on Purchase of Nonfarm Securities (1% of Value of Productive Assets) $ 363 - 363 Value of Investment Portfolio $35,887 The low cost retirement housing alternative, i.e. either a mobile home or retaining the farm dwelling, was assumed. The data in Table VI-8 indicate that MNW would incur capital 1“6 losses of over $10,100 and this represents a capital loss rate of 22 percent of the value of the productive assets prior to liquidation. With the 15 percent increase in social security benefits, MNW and his wife can expect to receive about $2,820 in annual benefits. His minimum retirement income of $3,000 is clearly attainable given this social security base, but his investment portfolio must provide a net income, after inflation, of $2,180 if he is to achieve the $5,000 income goal which he associates with a satisfactory retirement situation. This represents a net rate of return of 6.1 percent or a total return of 9.1 percent before inflation: thus, even with the low cost retirement housing alternative, MNW would have to liquidate some of his assets to achieve his $5,000 income goal, given the rates of return assumed for early 1970. A portfolio consisting of 60 percent equities, 30 percent fixed income securities and a 10 percent cash reserve is also recommended for MNW. The dollar returns from this portfolio are shown in Table VI-9. MNW could spend all of the income returns and still maintain the real value of the $36,000 portfolio. Their total annual retire- ment income would be nearly $“,700, which is very close to the $5,000 goal. By gradually liquidating his assets over a 15 year period, MNW could have a total real annual retire- ment income of about $6,330. The life expectancy data 1“? indicate that they would be assuming only a 10 percent chance of totally depleting their assets during their life- times. Table VI-9.--Estimated Annual Returns from the Recommended $36,000 Investment Portfolio (Dollars) Amount Price Income Total Type of Asset Invested Returns Returns Returns F Nonfarm Equities 21,600 1,080 86“ 1,9““ Fixed-Income Assets 10,800 0 86“ 86“ Cash Reserve M O __lf-L“ __li“ ' Totals 36,000 1,080 1,872 2,952 ' With their higher net worth and shorter life expec- tancy, MNW and his wife have much more flexibility in planning their retirement program than do LNW and his wife. MNW could spend more than $6,000 for his retirement housing and still come reasonably close to achieving his satisfactory income goal of $5,000. If he wished, he could also include a relatively larger amount of fixed-income securities in his portfolio to achieve a more stable retirement income. Liquidate only the farm chattels and rent the land out MNW's estimated retirement income under the rental alternative is shown in Table VI-lO. With the 22 percent estimated capital loss rate, the total income from the rental alternative is nearly the same as the total income l“8 from the $36,000 investment portfolio. The overall rate of return with the rental alternative is 6.6 percent and the break even rate correSponding to the 22 percent capital loss would be approximately 10.1 percent, assuming a 15 year period for recovery of the capital losses. Table VI-lO.--Estimated Annual Returns with the Rental Alternative for the Medium Net Worth Case (Dollars) Amount Price Income Total Type of Asset Invested Returns Returns Returns Farm Real Estate 30,000 900 1,050 1.950 Fixed-Income Assets ll,“00 O 912 912 Cash Reserve “.600 0 18“ 18“ Totals “6,000 900 2,1“6 3,0“6 The income returns from the rental alternative are $2,1“6, which, together with social security benefits, provide a maximum annual retirement income of $“,966. This level of retirement spending implicitly liquidates part of the portfolio because the price returns from the real estate are not sufficient to maintain the real value of the port- folio with a 3 percent rate of inflation. To maintain the real value of the $“6,000 portfolio, MNW would have to restrict his annual spending to 3.6 percent of the value of the port- folio, or $1,665, plus social security benefits of $2,820 for a total real, annual retirement income of $“,“85. 1“9 Although the farm real estate investment cannot easily be liquidated, MNW could gradually liquidate his $16,000 worth of liquid assets to supplement his retirement income. The average rate of return assumed for the bonds and savings accounts is 6.85 percent. The gradual liqui- dation of these assets over 15 years would provide a real income equivalent to nearly $1.“25 annually. This together with the $1,050 rental income and $2,820 social security benefits would provide a total annual retirement income of nearly $5, 300e Summgpy of thg medium nep wppth casg The rental alternative is recommended for the medium net worth case. This alternative provides a slightly higher expected income than does the liquidation alternative and it is consistent with the nonfinancial goals. The fact that the farm real estate investment cannot easily be liquidated is not a serious problem because he would have approximately $16,000 in liquid assets which could be liquidated should the need arise. Most of the other medium net worth cases ‘were not as fortunate in this respect and for them, the liquidation alternative would be better. High Net Worth Case Background informatipn HNW is 67 years of age and his wife is 60. He operates a 160 acre cash crOp farm, l“0 of which are tillable. In 1968 part of the farm was rented out because of HNW's 150 poor health. Unlike most respondents, HNW definitely plans to retire completely from active farming within the next 2-3 years. He would prefer to rent his farm out, although the sale of the farm on a mortgage was his second choice of alternatives for handling his real estate investment. HNW intends to reside in his mobile home in Florida during retirement. He estimated that an annual retirement income of $6,000 would be satisfactory and that they would need a minimum income of $3,600 per year. HNW now owns common stocks and he rated them as the best investment alternative. He rated savings accounts as the second best alternative, although his comments indi- cated that he is aware of their shortcomings. He considered mortgages to be the third best alternative. Ownership of common stocks, bonds and mutual funds was fairly common among the high net worth respondents. Financial position HNW's net worth statement is shown in Table VI-ll. Table VI-ll.--High Net Worth Case Balance Sheet Assets Cash and Checking Accounts $ 1,200 Savings Accounts 10,000 Common Stocks “,500 Farm Machinery 12,500 Personal Possessions (Including Mobile Home) 7,700 Farm Real Estate “8.000 Total Assets $83,900 Liabilitieg Owner Equity 8 00 Total Liabilities $83,900 151 In 1968, HNW received $3,800 in net rental and farm income, $1,000 in investment income and $85“ from social security benefits, for a total income of $5.65“. He currently receives only $122 per month in social security benefits but he expects to receive $2,“00 per year after retirement. Living expenditures for HNW and his wife were nearly $5,“00 in 1968 but this figure includes over $2,000 in Pat. medical expenditures. Their living expenditures by category were food--$780, housing—-$990, medical care--$2,062, transportation--$500 and miscellaneous expenses--$l,0“0. W I» HNW is probably the only one of the three cases who could possibly purchase a high cost form of retirement housing and still reach his retirement income goal. HNW and his wife are younger than the average survey respondent and they apparently enjoy an above average level of living so their retirement income portfolio must be carefully budgeted. Liquidate the entire farm business Table VI-12 shows the estimated capital losses for the high net worth case, assuming that a $16,000 house is purchased. Capital losses and incidental expenses would reduce the value of HNW's productive assets to around $52,000 from $76,200. The capital loss rate is around 32 percent but it would be reduced to only 19 percent if a low cost form of retirement housing was selected. 152 Table VI-12.--Estimated Capital Losses for the High Net Worth Case Total Value of Assets Before Liquidation $83,900 Less Personal Possessions $ 7,700 - 2.200 Value of Productive Assets Before Liquidation $76,200 Capital Losses Commissions for Realtor and Auctioneer (5% of $60,500 in Farm Assets) 3,025 Estimated Capital Gains Tax “.000 High Cost Retirement Housing 16,000 - 23.025 h_ Value of Productive Assets Following “ Liquidation $53,175 Commissions on Purchase of Nonfarm Securities (1% of 8, 75 $ “87 - “82 Value of Investment Portfolio $52,688 L : A $52,000 portfolio consisting of 60 percent equities. 30 percent fixed income securities and a 10 percent cash reserve would provide a total rate of return of 8.2 percent. He could Spend the equivalent of 5.2 percent or $2.70“ and maintain the real value of the portfolio at $52,000. His social security benefits, with the 15 percent increase. will be $2.760, so the estimated total annual retirement income would be $5,“6“. By gradually liquidating his assets over a period of 15 years. HNW could have a total annual retirement income of about $6,“50 which is in excess of his satisfactory retirement income goal. HNW has even more flexibility than the medium net worth case because of his strong financial position. For example, he is the only one of the three cases who should even consider selling his farm on a land contract. By selling his farm on an 8 percent land contract with 30 percent or 153 less down, he could reduce his capital losses by $“.000. Under this alternative, his estimated annual income before taxes would be as shown in Table VI-l3. Table VI-13.--Estimated Annual Returns with a Land Contract Sale for the High Net Worth Case (Dollars) Amount Price Income Total Type of Asset Invested Returns Returns Returns Nonfarm Equities 16.800 8“0 672 1,512 ‘ Land Contract (30% Down) 33.600 0 2.688 2,688 Cash Reserve (10%) 5.600 __9 22“ 22“ Totals 56.000 8“O 3,58“ “,“2“ Under this alternative. the total rate on the $56,000 portfolio would be 7.9 percent. This would be equivalent to a total rate of return of 8.5 percent on the $52,000 portfolio which he would have if the farm were not sold on a contract. The equivalent not rate of return after infla- tion would be 5.5 percent compared with the 5.2 percent return from the portfolio recommended above. The net differ- ence in annual income is only $160, which is probably negligible when the disadvantages of land contracts are considered. However, if the land contract sale reduced capital gains even further by increasing the selling price of the farm, it might be advantageous. The land contract is a possibly useful alternative only for those high net iii[ 7 H . | h l5“ worth cases who would have sufficient holdings of liquid assets to permit them to tolerate the lack of liquidity of a contract. Even then. a large land contract might be a serious problem in an estate settlement. Liquidate only the farm chattels and rent the land out HNW's investment portfolio and the income from it under the rental alternative are shown in Table VI-l“. E5 Table VI-l“.--Estimated Annual Returns with the Rental Alternative for the High Net Worth Case (Dollars) ?' Amount Price Income Total Type of Asset Invested Returns Returns Returns Farm Real Estate “8,000 l.““0 1.680 3.120 Fixed-Income Assets 21,000 0 1,680 1.680 Cash Reserve 6. 000 0 2“0 2“0 Totals 75,000 1,““0 3,600 5,000 This alternative provides an overall rate of return of 6.7 percent on the $75,000 portfolio. HNW could spend the equivalent of $2,775 of the income returns and maintain the real value of his assets at $75,000. On the basis of estimated annual returns, the rental alternative is clearly the better alternative for the high net worth case. The $5,0“O total return for the rental alter- ruative is equivalent to a 9.7 percent total rate of return 155 on the $52.000 portfolio which he would have by liquidating the farm business. An 11.2 percent rate of return would be needed to recover the capital losses in a period of 25 years. Given the assumed rates of return, there is no single nonfarm investment alternative which would provide this break even rate of return. If HNW were to select the low cost housing alternative, the break even total rate of return would be a .‘y only 8.1 percent. and the expected incomes from the liqui- dation alternative and the rental alternative would be about equal. Summgpy pf pap high 5 ngp wopth case The farm business liquidation alternative with the low cost housing alternative or the rental alternative both enable HNW to reach his satisfactory retirement income goal. HNW might be able to reduce capital losses significantly by selling his farm on a land contract with a down payment of 30 percent or less but this alternative is not recommended. Given their personal goals, retaining the farm and renting it out is probably the best alternative for the 'majority of the high net worth cases. The respondents in this group generally had large amounts of liquid assets so the lack of liquidity and income variability associated with farm real estate would not be a problem. The particular individual selected for this high net worth case analysis has already decided to liquidate his farnlbusiness and he has selected the low cost form of ril- V .m— 156 retirement housing. He has had some eXperience in managing a portfolio of nonfarm equity and fixed income securities. Summary In this chapter, several retirement investment programs were budgeted under three net worth levels. In each case. the objective was to plan an investment portfolio which would come as close as possible to achieving a Speci- I; fied retirement income goal and which would insure that this : amount of real income could be maintained during most of 3 the remaining expected lifetimes of the retiring farmer and E; his wife. It must be emphasized that the recommended port- folios were based on the eXpected rates of return for early 1970 and that a relative change in the rates of return among the investment alternatives would change the recommendations. The case study analysis indicates the importance of personal situations and retirement goals. The low not worth case has been prematurely forced into a partly retired situation because of ill health, while the medium net worth «case has been able to continue active farming well beyond the 'typical retirement age of 65. The high net worth case illus- 'trates the fact that- leaving active farming may sometimes 'be consistent with farmers' retirement goals. A summary of the total expected amounts of annual zwrtirement income from the recommended alternatives is shown ixifrable VI-l5. The estimated amounts of social security benefits are included in each case. Given the assumed rates 157 of return in Table VI-2, a 3 percent rate of inflation and average capital loss rates, the expected amounts of retirement income under the two major alternatives would be approxi- mately the same. The only financial advantage of retaining the farm real estate is the possibility of postponing the capital losses until illness or death force the retired couple to liquidate their farm assets. As was suggested earlier, delaying the decision to liquidate the farm assets may result in greater capital losses due to depreciation. Table VI-15.--Estimated Maximum Annual Retirement Incomea (Constant 1970 Dollars) Net Worth Liquidation of Farm Level Farm Business Rental LOW"$329350 3:800 3:760 (“9185) (3.880) Medium--$“8,500 “.700 “,“85 (6.330)* (5.300)* High--$83.900 5:465 5:535 (6.“SO)* (6.990)* aAmounts in parentheses show amounts available by totally depleting all liquid assets. *Indicates that the satisfactory retirement income goal is reached. Given approximately equal amounts of expected income fzrnn the two alternatives, the decision must be made on the basis of other factors. The year-to-year variability of the retirement income, risk, personal goals. and liquidity are probably the most important other considerations. ‘11! r“ H. 158 The liquidation alternative is clearly superior from the standpoint of the year-to-year variability of the income stream. and this factor is more important in the low not worth situation. Although the total returns to farm real estate have historically been more stable than the total returns to the nonfarm equities, the analysis in Chapter II indicated that common stocks and income mutual funds provided !, much more stable income returns. A cash lease on the farm real estate would provide stable income returns but at a considerable sacrifice in the amount of the expected returns. Given a high level of interest rates. a retiring farmer could E liquidate his farm assets, put nearly all of his money into _ high grade corporate bonds and achieve an almost perfectly stable annual retirement income with little sacrifice in returns. The low net worth case analyzed in this chapter could, for example, have a portfolio consisting of $18,000 in.corporate bonds and $2,000 in a savings account. His annual real income, with social security benefits would be $3,680 compared with the $3.800 income from the portfolio consisting of 60 percent equities. The dollar income from this portfolio would be perfectly stable but the amount of real income would vary slightly with changes in the rate of tinflation.and the general level of interest rates. The hypothetical depression analysis in Chapter II indicated that the returns to nonfarm equities would decline more during an economic depression than would the total returns to farm real estate. However, the retired farmer who 159 has already liquidated his farm assets could easily increase the proportion of fixed income securities in his portfolio if the probability of a depression increases. In doing so, he could avoid serious capital losses. Thus. from the stand- point of risk. the liquidation alternative is preferable. The survey results clearly indicated that the rental alternative is more consistent with farmers' nonfinancial ‘7 retirement goals. Their desire to continue to live in the farm home and to exercise some degree of managerial control over the farm business must be recognized as important retirement goals. Their generally negative attitude toward nonfarm securities rules out the liquidation alternative for many retiring farmers. Retaining the farm and renting it out is probably the better alternative for most medium and high net worth situations. Their liquid financial position.would enable them to tolerate the illiquidity, income variability and risk associated with an investment in farm real estate. The rental alternative would not be suitable for most low not worth retirees because they generally do not have enough liquid assets to provide a supplementary investment portfolio. The rental alternative would provide a low and jpossibly a highly variable income and it would be impossible to gradually liquidate assets to meet retirement income needs. Ironically, very few of the low not worth respondents owned nonfarm securities and they showed a greater tendency to :rate them as the poorest investment alternatives. CHAPTER VII SUMMARY AND CONCLUSIONS The single proprietorship continues to be the predominant form of business organization for agricultural production in the United States. Under this form of busi- ness organization, the firm growth cycle is closely related to the life cycle of the proprietor, and generally, the business terminates with the disinvestment stage when he voluntarily or involuntarily withdraws his labor, management and capital from the business. The objectives of this study were first, to describe the important financial and personal characteristics of retirement age farmers and second, to recommend disinvestment strategies which would fulfill the financial and personal goals of retirement age farmers. The Problem Area According to the 196“ Census of Agriculture data. two-fifths of the census farms in the United States were operated by persons 55 years of age or over. Old age and the accompanying decline in physical health eventually make it impractical for elderly pe0ple to continue active farming. 160 161 The assets which they control must be converted to sources of retirement income and ultimately transferred to a younger generation of farm operators. The disinvestment stage is one which may be easily mismanaged. The asset value of the farm firm is relatively high at the beginning of this stage and farmers are not generally familiar with the kinds of financial and personal #2 problems which they encounter as they grow older. Most elderly ‘ farm people apparently receive lower incomes than either younger farmers or other elderly and retired persons in the 7" . population. Despite the importance of disinvestment, compar- E atively little previous research has been done on the personal 1 and financial problems of retiring from active farming. Some of the related research has dealt with certain aspects of disinvestment such as estate planning and the inter- generation transfer of resources. For the most part, the problems of converting farm assets to sources of retirement income have been overlooked. Summary of the Survey Results A random sample of fifty farmers and retired farmers from Southern Lower Michigan was interviewed during July and August of 1969 to obtain some basic descriptive infor- mation on their financial positions and retirement goals and to determine the constraints which would affect their retirement programs. 162 Some of the principal findings of the survey are summarized in Table VII-l. Twenty-one of the reapondents were completely retired from farming and 29 were either partly retired or still farming. Table VII-1.--Summary of Principal Findings of Survey Mean Median Background Respondent's Age 72.1 71 Age of Spouse 71.0 70 Education (Years) 9.3 8 Year Started Farming 192“ 1926 Financial Position Income During 1968 $ “.30“ $ 3.58“ Living Costs During 1968 3.36“ 3,276 Net Worth 57.220 52,150 Retirement Income Goals --Satisfactory Income “,“0“ “.“00 --Minimum Income 2.829 2,750 Social Security Expectations $ 1,“23a $ 1,500a aBased on survey data. Social security benefits ‘were increased by 15 percent over the amounts shown in December 1969. Several important conclusions can be drawn from the survey results. First, very few farmers apparently make definite plans to leave active farming or to transfer their estates to their heirs. Half of the survey respondents who had completely retired had done so reluctantly because of ill health and nearly three-fifths of those who were still farming said they had not yet made plans to retire from 163 farming. Only half of the respondents carried life insurance and the average face value of their coverage was only $1,700. Only one-third of the respondents had made a will deepite the fact that their average age was over 72 years. Most respondents expressed a preference for staying in the farm home and continuing to work actively in farming as long as possible. These findings suggest that "retirement age” to F‘ many farmers is not a prespecified point in time as is the ; case in most nonfarm occupations. Instead, it is the age at é which ill health or other adverse circumstances force them i to withdraw from active farming. Usually, retirement is a E gradual process which takes place over a period of several ' years. Many farmers simply allow their nonreal estate assets to depreciate out instead of liquidating them. In some cases. the depreciable portion of the real estate investment also deteriorates during this gradual disinvestment process. A second conclusion is that most elderly farmers are receiving very low income returns from their productive assets. In 1968. the average income rate of return on farm assets owned by the survey respondents was only 3.3 percent and the overall average income rate of return on all produc- tive assets was only 3.6 percent. Social security benefits were their most important single source of income. and this source accounted for about one-third of the average survey respondent's income in 1968. Although the average respondent had a net worth of nearly $60,000. ““ percent had net worths of less than l6“ $“0,000. The average respondent had more than enough income to cover his living costs in 1968, but an examination of the individual questionnaires showed that in about half of the cases, living expenditures exceeded incomes. The combinatiom.of comparatively low net worths, low rates of return on productive assets and low incomes suggests that one important problem of the disinvestment stage is generating enough retirement income from accumulated assets. Recommendations The survey results suggested a need for information and procedures which would be helpful in analyzing retire- s ment decisions. The basic financial problem confronting the retiring farmer is to select a portfolio of assets which will produce an income stream which has characteristics consistent with personal preferences for expected returns. income vari- ability and risk. The closely related personal problem of disinvestment is to achieve a retirement situation which is consistent with personal preferences for living accommodations and location, work and leisure activities, and family goals. zin v stm alte atives The selection of assets for an investment portfolio is a highly personal matter. Individual preferences deter- mine the types of assets which will be included in the port- f01io and the manner in which available funds will be allo- cated between cash and risky assets. 165 Risk was defined as the probability of losing all or part of the initial capital invested in an asset. Assets are subject to four types of investment risk: business risk. market risk, interest rate risk, and purchasing power risk. The degree of investment risk depends partially on the prob- ability that assets will have to be liquidated when their market prices are depressed. Elderly people are more likely to incur unexpected medical eXpenses, so they must be in a position to liquidate asset holdings on relatively short notice. Death usually results in the liquidation of all or part of the asset holdings for estate settlement purposes: thus, life expectancy information is useful for evaluating investment risk as well as for determining the appropriate time horizon for retirement planning. The total returns from an asset consist of price returns which result from changes in market prices and income returns in the form of profits. dividends, interest, and rent. Investors must consider both types of investment returns when evaluating their alternatives but the relative desirability of price returns versus income returns will vary among individuals. Eight representative investment alternatives were analyzed for their historical performance. The period 1955 to 1968 was chosen to represent an actual period of general economic prosperity. These data were also analyzed in reverse order to simulate investment performance during a period of 166 economic depression. The analysis of the historical perfor- mance of the investment alternatives illustrated the fact that high returns can normally be achieved only by accepting a higher amount of income variability. This analysis also indicated the importance of forecasting economic conditions and adjusting the relative proportions of equity and fixed income securities in the portfolio accordingly. If a period of economic depression seems imminent, the investor should reduce his holdings of equities and invest heavily in long term fixed income assets. If economic prosperity is fore- cast, equities will provide the best results and the fixed income portion of the portfolio should be in short term securities. In addition to the empirical analysis, the invest- ment alternatives available to retiring farmers were examined in terms of how well they fulfill the other characteristics of a desirable investment -- liquidity and ease of manage- ment. Liquidity is particularly important for the elderly investor. Assets which can be liquidated quickly and in small units permit the investor to convert price returns to income returns and to adjust his portfolio for changing economic conditions. Although farm real estate has histori- cally provided only slightly lower total returns than nonfarm equities, the illiquidity of farm real estate makes it virtually impossible to liquidate capital to meet income needs or to switch to fixed income securities when the economic 167 outlook becomes unfavorable. Liquidity is also important from the standpoint of estate settlement. Estates which consist largely of liquid assets can generally be settled more quickly and with less expense than estates which con- sist largely of real property. Thus, on the basis of liqui- dity. nonfarm equity and fixed income securities are superior to farm real estate, land contracts or farm mortgages. In certain cases a retiring farmer might wish to sell his farm on a land contract or mortgage. For example. there may be a personal desire to provide financing for a relative or the availability of financing may increase the sale price of the farm. In general, however. land contracts or mortgages should be avoided because of their lack of liquidity. For most retiring farmers, farm real estate is superior to nonfarm equities in terms of ease of management. There are situations in which finding and retaining a capable tenant might be difficult for an elderly retired farmer or a surviving Spouse: however, because of their lack of previous contact with common stocks, bonds and mutual funds, the management of a portfolio of nonfarm securities poses serious difficulties for retiring farm people. Professional investment advice and portfolio management are (available on a fee basis to persons who have portfolios of $100,000 or more. Given the range of net worths of the survey respondents, this alternative is apparently not available to most retiring farmers. 168 The novice common stock investor must rely primarily on the advice of a broker. A competent broker can usually provide reliable advice on establishing and managing a common stock portfolio. Investment counselling may also be obtained on a formal or informal basis from most commercial banks. Mutual funds are a possible solution to the problem of managing nonfarm equities. Retiring farmers should study er the historical performance of several funds before making a selection. Studies of the mutual funds have shown that some individual funds have achieved consistently poor results. Thus, the retiring farmer should diversify among two or three mutual funds which have investment objectives similar to his own. Nonfarm fixed income securities are comparatively easy to select and manage. Corporate and government bonds can be obtained through brokerage firms and banks at a reasonable cost. Government bonds can be safely purchased with no financial analysis and the default rate on high grade corporate bonds has been very low. Annuities offer safety of principal and income stability but. because of their comparatively low rates of return and their lack of liquidity. they are generally unsuitable for retirement income purposes. Pppcedupes f9; analyzing pgpipemenp dgcis ops The basic decision to be made by the retiring farmer is whether to liquidate the entire farm business or retain 169 the farm real estate and rent it out to a tenant. Although many of the survey respondents had continued to farm well beyond the typical nonfarm retirement age of 65, most elderly farmers or their surviving spouses must eventually select one of these alternatives or some combination of the two. Personal considerations are of major importance in the analy- sis of this decision but an adequate analysis cannot be made without a thorough consideration of the financial aspects. The financial analysis of the liquidation and rental alternatives in this study consisted of estimating the total amounts of real annual income under each alternative. Historically, nonfarm securities have provided higher returns but capital losses incurred in the conversion process must be taken into account. The individual farmer should determine whether he can earn a breakeven real rate of return on his assets following liquidation and this break even analysis should be related to some time horizon based on his life expectancy. Estimating capital losses The retiring farmer who liquidates his entire farm business incurs eXpenses such as capital gains taxes, com- missions and retirement housing costs which reduce the amount of his earning assets. These reductions in the value of productive assets were referred to as capital losses, although some eXpenditures, such as the purchase of a retirement dwelling, are not actually capital losses. 170 If the average survey reSpondent were to liquidate his farm business, capital losses would range from about 11 percent to nearly “0 percent of the value of the produc- tive assets which he owned prior to liquidation. The lower capital loss rate could be aflueved by selling the real estate and chattels without the services of a realtor or auctioneer and purchasing a $6,000 dwelling for retirement. It was assumed that the low cost dwelling could be obtained by purchasing a mobile home or retaining the farm dwelling when the farm is sold. The high capital loss rate was based on realtor's and auctioneer's commissions of 10 per- cent of the estimated market value of farm assets and a $16,000 retirement dwelling. The case study analysis indicated capital loss rates of 31 percent for the low net worth situation and 22 percent for the medium net worth situation, where both estimates were based on the low cost form of retirement housing. Capital losses for the high net worth case ranged from 19 percent to 31 percent depending upon the cost of retirement housing. Commissions for the sale of the farm assets were assumed to be 5 percent of the estimated market value of these assets in all three cases. It was assumed that the entire amount of the 10 percent commissions should not be regarded as capital losses because the services per- formed by realtors and auctioneers usually result in higher gross selling prices. 171 A break even analysis was used to estimate the effect of capital losses on retirement income. The rates of return needed to provide equal amounts of retirement income following liquidation were computed for the typical range of capital loss rates. Using the average situation of the survey reapon- dents as an example. suppose a retiring farmer has $50,000 __ worth of productive assets prior to liquidation and that he i can earn a total rate of return on these assets of 5 percent. The break even return needed to provide an equivalent amount of annual income following liquidation with a 25 percent capital loss rate would be about 6.7 percent. He would have to earn an additional 1.5 percent if he wished to recover the $12,500 capital losses in a 20 year period. Thus, a 5 percent rateof return prior to liquidation would be equivalent to an 8.2 percent rate of return following liquidation. Selecting investment alternatives The investment portfolios in the case studies were based on assumed rates of return for early 1970, i.e., farm real estate, 6.5 percent: nonfarm equity securities. 9.0 percent and fixed income securities. 8.0 percent. The over- all rate of return for each of the recommended alternatives was adjusted for inflation by deducting an assumed 3 percent rate of increase in the price level. 172 The underlying assumptions for these rates of return are important. Farm real estate prices were eXpected to increase at the rate of 3 percent per year. The 3.5 percent income rate of return from farm real estate was based on the survey results which indicated a 3.3 percent income return and on the 1955-1968 national average yield of 3.8 percent. The 9.0 percent rate of return on nonfarm equities may seem r; high given the limited capabilities of a novice investor. é However, in early 1970, the general price level of common j stocks was very low by recent historical standards. The : widely quoted Dow Jones Industrials Averages, which approached E 1,000 on two occasions during the 1960's were below 750 during January 1970. Common stocks which are purchased when prices are generally depressed will yield above average price returns. The net asset values of most mutual funds also decline when stock prices are depressed so they too would provide high price returns based on early 1970 equity prices. The case study analysis showed that, given the assumed rates of return, the liquidation alternative would result in a slightly higher annual retirement income than would the rental alternative for the low and medium net worth situations. For the high net worth situation the rental alternative was slightly better, assuming that the high cost retirement dwelling was purchased. A low cost retirement dwelling would leave the high net worth case with enough productive assets to earn a break even annual income under the liquidation alternative. 173 On the basis of real annual retirement income, the rental alternative would be better for all three net worth levels if the general level of stock prices was high or the general level of interest rates was low by recent historical standards. The combination of depressed nonfarm equity prices and historically high bond yields suggests that early 1970 would have been a relatively good time to liquidate farm m. assets and invest in a portfolio of nonfarm securities. A I; general implication of this study is that retiring farmers should make definite plans regarding the liquidation of their . farm assets before reaching retirement age but, if possible. E! they should implement this plan when the general outlook for nonfarm securities is favorable. If this timing strategy is followed. the real rate of return on a portfolio of non- farm securities will generally be high enough to compensate for normal amounts of capital losses. Implications of the Study A general conclusion of this study is that farmers and their families should make definite plans regarding retirement and the transfer of their estates before serious illness or death forces them to do so. I A minimum estate transfer program should probably include a will and enough permanent life insurance cover- age to meet the financial needs of dependent heirs while the estate is being probated. Depending upon the circumstances, other estate transfer devices such as a trust, incorporation, 17“ or co-ownership of assets may be useful to insure that need- less capital losses are avoided and that assets are distri- buted among heirs in the desired manner. Unless there are strong personal motives for retaining the farm real estate, liquidating the farm business and either retaining the farm dwelling through ownership or a life estate or purchasing a low cost retirement dwelling is probably the better retirement alternative for most farmers. The higher returns from nonfarm assets will usually compen- sate for the capital losses incurred in the liquidation process. Also. the income returns from a portfolio of non- farm securities would be more stable than the income from a farm business or the rental income under a share lease arrangement. The flexibility and liquidity of a portfolio of nonfarm securities permit the retiree to use his capital for retirement income needs and to adjust the equity and fixed income components of the portfolio according to changing economic conditions.’ Personal goals associated with living on the farm, retaining managerial control of the farm real estate during retirement and the obvious difficulties of managing the equity portion of a portfolio of nonfarm securities are the more compelling reasons for not liquidating the farm assets. Retaining the farm real estate probably fulfills the personal retirement goals only as long as both the retired farmer and his wife are in good health. A rural location becomes a disadvantage when ill health makes automobile transportation If“! 175 impractical or when regular medical care is required. Furthermore, the life expectancy data indicate a high proba- bility that the farmer will predecease his wife. The diffi- culties of managing the farm business or liquidating the farm assets would be especially serious for a surviving spouse. If continuing to live in the farm home is an important retirement goal, as it appears to be for many pe0ple, a rea- sonable compromise between the liquidation and rental alter- natives can be achieved by retaining the farm dwelling when the farm is sold. This alternative probably minimizes capital losses in addition to fulfilling most of the more important personal retirement goals. Unfortunately. the liquidation alternative requires that funds derived from the sale of farm assets be invested in.common stocks, mutual funds, bonds and other nonfarm’ securities. Most farmers understandably regard these types of assets as being too risky for a retirement income port- :flalio. The selection of nonfarm fixed income securities such as corporate or government bonds and savings accounts does rx>t appear to pose a serious problem. However, some nonfarm equity securities are an almost essential part of the port- :fielio, particularly during a period of economic prosperity. Common stocks are suitable only for people who have some familiarity with the analysis and selection of nonfarm Securities or who have access to competent investment cOunselling. Historically, common stocks have provided highly variable price returns and fairly stable income 176 returns. Therefore. the common stock investor should have enough liquid reserves to minimize the probability that he will have to sell stocks when their prices are low. Also, his temperament should be such that he will not be psycho- logically disturbed when the prices of his stocks are temporarily depressed. Retiring farmers who lack the ability or the willing- ness to tolerate the price fluctuation of common stocks should consider the merits of mutual funds. Mutual funds must be carefully selected but once the selection has been made, they require much less supervision than common stocks. The net asset values of mutual funds are generally more stable than the prices of common stocks. These character- istics of mutual funds make them more suitable for low not worth situations in which the lack of liquidity is usually a problem. Retiring farmers who have medium or high net worth levels will generally be able to achieve their financial retirement goals with either the liquidation or rental alternative. Many people with low net worths will have to liquidate some of their capital to achieve their retirement income goals. This need for liquidity implies that if possible. assets such as farm real estate and land contracts should not constitute a large proportion of their assets. 17? Suggestions for Further Research Additional research is needed to provide information and techniques which would be useful to the retiring farmer in evaluating his retirement alternatives. ‘ There is a need for more accurate estimates of the capital losses which occur when farm assets are converted to sources of retirement income. Research is needed to deter- a mine to what extent the market values of farm assets are affected by the neglect which occurs after an elderly farmer becomes incapable of continuing to farm. The effects on the market values of farms of retaining the dwelling by excluding it from the sale or by means of a life interest should be studied further. The results of this type of arrangement in terms of the retiring farmer's personal and financial goals should also be evaluated. Many people remain on the farm during retirement because of the relatively higher living costs associated with a nonfarm location. Additional research is needed to obtain comparative data on farm and nonfarm living costs for elderly people. Information on the personal experiences of farmers who have retired in a nonfarm environment would also be useful. Finally, this study did not deal adequately with the problems confronting the novice investor. Research is needed to determine how financial and educational insti- tutions could better assist retiring farmers in selecting 178 and managing a portfolio of nonfarm securities. Potential sources of investment advice and counselling for the low net worth investor should be identified and evaluated in terms of their cost and their performance. “i-FLL '.‘ I .-__ ’L l“ I m.‘ BIBLIO GRAPHY BIBLIOGRAPHY Books Arthur Wiesenberger Services. Investment Companies 1969-- Muppal Funds and Othpp Types. New York: Nuveen p Corporation. 19 9. ‘ Atkinson, Thomas R. Tpgpdg in Copporate Bond Quality (Studies in Corporate Bond Financing No. , National Bureau of Economic Research). New York: Columbia University Press. 1967. at - Cohen, Jerome B., and Zinbarg, Edward D. Investmept Apalysis, Ppipciples and Technigues. New York: McGraw-Hill, InC. 19 20 Graham, Ben amin. The Intelligent Investop (3rd revised ed.). New York: Harper and Row. 1965. : Dodd. David L.: and Cottle, Sidney. Secupipy Apalysis, Pripciples gpd Techniques. New York: McGraw-Hill. Inc. 19 2. - Johnson, G.L.. pt 31. M 'al P cesses of Midweste F ers. Ames: The Iowa State University Press, 1981. Standard and Poor's Trade and Securities Statistics. S u P ' e Ind x Re 0rd: 1 68 diti . Orange, Conn: Standard and Poors Corporat on. 1969. Youmans. E.G. (ed.). Olgg; Rural Amepicgps: g Sppiologicgl ngspecpivz. Lexington: Un versity of Kentucky Press. 19 7e Appi lgs, Bulletins gpd Pgripdicals Benson, Richard. "Money Likely to Remain Tight.” Michigan Fapm Economics, No. 323 (December 1969). East Lansing: Michigan State University, COOperative Extension Service, Department of Agricultural Economics, 1969. 179 180 Boyne, David H. thpges in the Real Wealth Positiop of Farm Operators, l9 0-19 0. Technical Bulletin 29 . East Lansing: Michigan State University. Agricultural Experiment Station, Department of Agricultural Economics. 196“. Brake, J.R. ”Impact of Capital Structure on Capital and Credit Needs.” rn of Fa conomics. Vol. “8, No. 5 (December 1986). , and Wirth, M.E. e Michi an F Credit Pane : A Hispppy pf Capipgl Accumplation. Research Report No. 25. East Lansing: Michigan State University, Agricultural EXperiment Station. Department of Agricultural Economics, 196“. Cotner, M.L.: Wirth, M.E.: and Irwin, G.D. ngplplpgppg 5 in phe Lang Mapkep: A Profile pf Renters, Buyeps, gpd Sellers in Lower Michigan. Research Report No. 12. East Lansing: Michigan State University, Agricultural Experiment Station, Department of Agricultural_Economics, 196“. Edwards, C.M. Co f Ho si in Th ee T s o w 111 : prsg, Apartment, and Mobile Hpme. Information Series No. 237. East Lansing: Michigan State University, Cooperative Extension Service. Agri- cultural Engineering Department, 1968. Fraine, Harold G. and Mills, Robert H. ”Effect of Defaults and Credit Deterioration on Yields of Corporate Bonds." T e Jo al of Financ . Vol. XVI. No. 3 (September 1961). Friend, Irwin and Vickers. Douglas. "Portfolio Selection and Investment Performance.” e u al of Flpgpgg, Vol. XX, No. 3 (September 1985). Harrison. GeAe’ SCOttg JeT03 and Baker, CeBe "The Use Of Linear Programming in Estate Planning.” Illinols A 'c ral Eco om' 8, Vol. 8, No. 2, Urbana: University of Illinois. Agricultural Experiment Station. Department of Agricultural Economics. 1968. Hepp, R.E. and Kelsey, M.E. A Study Optline fpp Estape W- Ae- Econ. Misc- Series No. 19 -11. East Lansing: Michigan State University, C00perative Extension Service. 1966. Hill, E.B. nghgp-Spp Eapmipg Agregmgpts: Spmg Imporpant and Irppblgspme Features. Research Report No. 5 . East Lansing: Michigan State University, Agricul- tural Experiment Station, Department of Agricultural Economics, 1966. 181 . ngm Trgpsfeps gpd Estate Settlemepts--Taxes. and Legal Costs. Extension Bulletin 2 . East Lansing: Michigan State University, CoOperative Extension Service. September 1968. , and Fitzgerald. J.W. The Lgpg Coptract a§ a Farm F' . Special Bulletin No. 31. East Lansing: Michigan State University. Agricultural Experiment Station. Department of Agricultural Economics, 1966. Mead. Stuart B. "Mutual Funds from the Investor's VieWpoint." N s' 5 'cs, (Winter 1967). North Central Regional Committee. Family Farm Irgpfifepp and Spmg Tax Cppsldepgpipps. Special Bulletin 3 . East Lansing: Michigan State University. Agricul- tural Experiment Station. Department of Agricultural Economics, 196“. Projector, Dorothy S. and Weiss, Gertrude S. Sprvgy of Flngnplal thpagpgplstipp pf Qopspmers. Washington, D.C.: Borad of Governors of the Federal Reserve SYStem, AugUSt, 19660 Reiss. F.J. Whgp Is g Ealp Qppp-Spgpe Lfiase7. Circular 918. Urbana: UniverSity of 111 015, Cooperative Extension Service. 1965. Sauer. H.M.: Bauder, W.W.: and Biggar. J.E. Rgtlyemenp s C e ts and ttitudes of Farm 0 e ato s in T e a t South Dak a Counties. Bulletin 515. Brookings: South Dakota State University, Rural Sociology Department in cooperation with Farm Population Branch. USDA, ERS. June 196“. Sharp, W.F. ”Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk." h p£_£lngppp. 'Vol. XIX. No. 3 (September 196“). Wright. K-To. and Gaul. D-A- MW- Extension Bulletin 582. East Lansing: Michigan State University, COOperative Extension Service, August 1967. G v b a ' s A i ance ev' w. Washington: USDA, ERS. Farm Production Economics Division, Vol. 29 and 30, Supplements. 182 Cope. E.M. and Liston, L.L. C t O erat an utomob' e. Washington: U.S. Department of Transportation. Federal Highway Administration, 1968. Fa R a e M k v 0 me 8. Washington: USDA. ERS. August 19 9. U.S., Department of Commerce, Bureau of the Census. 126“ U e S es C o A c t . Vol. II. Chapters 5 and . U.S., Department of Commerce. Bureau of the Census. United S es e T ble : -61. WW Huff, H.B. ”Land Values and Valuation: A Landlord Approach." Unpublished M.S. thesis, Michigan State University, 1967. Host, W.E. "Investing in Farm and Nonfarm Equities." Unpublished M.S. thesis, Michigan State University, 19 7. APPENDIX APPENDIX Letter 39 Bpggpggpr§ Sppygy Respondepts Dear Mr. ( ): i The Department of Agricultural Economics at Michigan State University is doing research on the subject of retiring from farming. The purpose of this research is to study farmers' plans for retiring and to find out how retired farmers have made the change from active farming to retire- ment. In order to obtain some first hand information for this study, farmers and retired farmers from selected town- ships across Michigan are being interviewed. ( township is one of our sampling areas, and we would like you to participate in our study. Within the next week or two our interviewer. Mr. ( ), will be contacting you to arrange for an interview. We sincerely hope that you will be able to cooperate in this project. The information obtained from the many persons being interviewed will be extremely valuable in helping us to gain a better understanding of the problems of planning for retirement. We assure you that the information which you provide will be kept strictly confidential. Sincerely. John R. Brake Professor 183 l8“ Sprvgy Quegtipppgipe CONFIDENTIAL DEPARTMENT OF AGRICULTURAL ECONOMICS MICHIGAN STATE UNIVERSITY RETIREMENT STUDY Farm Location County Township Respondent Name Address Date of Interview Interviewer 185 (Questions 1 to 9 for all respondents) First, we would like you to think for a moment about what might be a satisfactory retirement situation for you, forgetting any Specific financial or other limitations which might prevent you from achieving this situation. 1. (a) Here is a list of laces that a retired farmer might live (Card 1 . Which one would you prefer? on a farm, in the country. but not on a farm. in a village or small town (under 5,000 pap.) in a large town or city, or in some other location (specify) (Mark re3ponse as (1) then proceed) Now, could you also give your second and third choices? (b) In what part of the country would you live?... (Read list) within 25 miles of here. another location in Michigan, or another part of the country (specify state) (c) What kind of housing would you prefer? Please give us your(first,)second, and third choices from this ' Card 2 H g... m d' a your own house. a rented house, an apartment, a mobile home, a nursing home, a boarding house, another kind of residence (describe) 2. (a) Now, what about working during retirement. Would you want to work during retirement? No Uncertain Yes--What kind of work would you do? 1).. 3. h. (a) (a) (b) 186 We want to know how you would occupy your leisure time? Are there any of these activifies which you would like to follow during retirement? (Card 3) (Check the activities mentioned and briefly record any comments.) reading hunting and fishing visiting friends radio and television clubs, church, organizations sports (golfing, bowling, etc.) traveling gardening other hobbies or activites (describe) comfortable retirement situation at today's conditions? (£- per month or $ per year What is the minimum income you feel you would need? '69- per month or $ per year. Next, we would like to obtain some information about your background and your family. 5. (a) (b) (o) (d) Please tell us your approximate age. Are your married? No Were you ever married? No Yes Yes Could you please tell us your wife's approximate age? Did you grow up on a farm? No Yes When did you start farming on your own? Year. 19 187 6. Have you ever worked off the farm for income? 7. (a) (b) 8. (a) (b) (o) No Yes How many years did you work at an off-farm job? years What kinds of work have you done? What was the last grade of school you completed? th grade Did you receive any additional training such as short course or vocational training? éafifl, No , Yes How long was this training? months What kind of training was this? V w \ I A a ' - m I (If respondent is or was married) Do you have any children? No Yes We would like to know (ii) the number of children who are still dependent on you for financial support . (iii) the number of family members, that is, sons or sons-in-law, who are farming . (iv) the number of family members who are not farming now but who intend to farm in the future How many other persons (besides your wife) (and children mentioned) are dependent upon you for financial support? . Have you provided or do you intend to provide finan- cial or other assistance to help a family member or someone else become established in farming? NO . -- Proceed to question 9 Uncertain Will provide -- Proceed to part (d) Have prov1ded 9. 188 (d) (i) Who have you helped (or will you be helping)? son or son-in-law other relatives other (ii) What kind of assistance have you given (or will you be giving)? Which of the following would best describe your present employment situation as far as farming is concerned... completely retired (Questions 10 to 13 Yellow) giifiyfzimiggd' or“(Questions 14 to 17 Green) (Questions 10 to 13 for retired reSpondents only) 10. 11. (a) How long have you been retired from active farming? years. (b) Please tell us why you retired from farming when you did. (Obtain rank if more than one reason given. Read list only if necessary to explain question.) health problems family members wanted to take over not enough money from farming too much work in farming became eligible for social security other reasons (describe) (a) We want to know what type of farming you carried on the last three years before you retired. What enterprises did you have, how large were these enterprises and approximately what percentage of the total or gross farm income came from each? Numbe; 0;: Percentage of T t S 8 Dairy cows milked Beef cows fed Fed cattle sold Sows farrowed Market hogs sold Broilers sold Laying hens Turkeys ‘6me 189 110 (3.) cont. Percentage of Number of: T S e Cash Crops Acreage Corn CC Wheat Navy Beans Soybeans Other Fruit or Market Gardening Crops Acreage Pl— Other Enterprises Type Size J (b) 1. How large was your farm? acres. How many acres were tillable? ii. How many acres of this did you: own rent (c) Please tell us the approximate annual total or gross income from your farming operations during the last three years that you were farming. 12. Now, we would like to know what you did with your farm assets when you retired from farming. (a) First, did a family member or other relative take over the farm? No Yes Who was this? son or son-in-law other relative other 13. (b) (e) (d) (a) 190 What did you do with your farmland? sold for cash sold on mortgage sold on land contract kept and rented out kept for own use in farming other or combination of above (describe) What did you do with the livestock, equipment and so on? sold by auction sale private sale kept and rented out kept for own use in farming other (describe) Could you tell us why you chose to handle your farm assets the way you did? (Refer to answers to parts (b) and (c) Please indicate from the following list the sources and amounts of your family income for the past year. (Please include any income received by your Wife e ) a1 £2!“ M Net rental income from farm property Net rental income from nonfarm property Net farm income (includin government payments? Salary or wages Interest and dividends from investments Social security Pension or retirement plan Life insurance or annuities Welfare benefits Financial support from relatives or friends Other sources of income (describe) Total Income 191 (b) Was your total income for last year higher, lower, or about the same as usual? about the same higher -- Please explain why your income was lower -- (higher, lower) than usual (c) (i) Where have you lived since you retired? (Record location and kind of dwelling) (ii) Do you expect to stay here throughout your retirement years? I‘ No Where do you plan to live? Yes Uncertain (d) Many people make plans for their retirement before reaching retirement age but sometimes plans must be changed. In what ways do you feel your actual # retirement situation differs from what you eXpected t to be? (e) Have you been generally satisfied with your retire- ment program? Yes No Why? (Questions 1h to 17 for respondents who are not retired.) 1h. Do you think that you will eventually leave farming entirely? No Uncertain Yes At what age do you plan to retire . 15. (a) We want to know what type of farming you carry on now. What enterprises do you have, how large are these enterprises, and approximately what percen- tage of your total or gross farm income comes from each? Percentage of Number 9: ~ T S es Dairy cows milked D“ Beef cows fed 3 Fed cattle sold _ Sows farrowed S Market hogs sold 192 150 (8.) cont. Percentage of MN be f We Broilers sold P Laying hens Turkeys Cash Crops Acreage Corn CC Wheat Navy Beans Soybeans Other Fruit or Market Gardening Crops Acreage Other Enterprises Type Size (b) (1) How large is your farm? acres How many acres are tillable? (ii) How many acres of this do you...Own? Rent? (c) (i) Please tell us what has been the average annual total or gross income from your farming operations during the last thrgg years? (d) Please indicate from the following list the sources and amounts of your family income for the past nu- ma mm: Net rental income from farm property Net rental income from nonfarm property Net farm income (includin government payments? Salary or wages Interest and dividends from investments 15. 16. (d) Now, farm (a) (b) (e) 193 cont. Annual Amount Social security Pension or retirement plan Life insurance or annuities Welfare benefits Financial support from relatives or friends Other sources of income (describe) Total Income we would like to know what you plan to do with your assets when you retire from farming. First, will a family member or other relative be taking over the farm? No Uncertain Yes Who will this be? son or son-in- law other relative other What do you plan to do with your farmland? Please indicate your first, second, and third choices from this list. (Card #) sell for cash sell on a mortgage sell on a land contract keep and rent out keep for own use in farming, or other or combination of above (describe) What do you plan to do with your livestock, equip- ment, and so on? Please give your first, second, and third choices from the following list. (Card 5) sell by auction sale private sale keep and rent out keep for own use in farming other (describe) 19h (d) Please give your reasons for your preferences. (Ask about No. 1 choices) (e) How will you Spend or invest any money received from the sale of your farm assets? 17. (a) Now, we would like to establish an estimate of the probable sources and amounts of your family income when you retire. First, how about social security? Can you tell me how much income you (and your wife) will receive from social security? Yes $ Uncertain -- Okay, maybe you can tell us the No-- approximate yearly average net income for social securit purposes over the last five years. i (b) Now, what other sources of family retirement income will you (and your wife) have? If possible, we would like an estimate of the amounts. (Read list, check sources, and record amounts.) Animal. Sgugce Amount Net rental income from farm property Net rental income from nonfarm property Net farm income (includin government payments? Salary or wages Interest and dividends from mortgages, contracts and investments Pension or retirement plan (other than social security) Life insurance or annuities Welfare benefits Financial support from relatives or friends Other sources of income (describe) Total (Ask remaining questions of all reSpondents.) 18. Do you feel that you will have enough income throughout your retirement years or do you expect to have financial problems? 195 19. Now, we would like to get an idea as to what your family living expenses have been during the past year. (a) (b) (o) (d) (e) Yes What is the make and year? How much do you normally spend on food, beverages, and other grocery items in say a week or month? per (week, month) Annual Amt. $ Now, what about your housing costs? What would be the approximate amounts of: Rent payments $ Mortgage payments Property taxes Utilities (fuel, electricity, telephone) Maintenance and repairs on house (average) Insurance on house and contents Other expenses (list) Subtotal $ How much do you usually spend on health care? Medical insurance premiums $ Doctor and hoSpital care Dental care Drugs and medicines Eyeglasses Other __1 Subtotal $ Do you own a car? $ No Approximately how many miles do you drive in a year? Do you have any other transportation expenses, such as bus, train, plane, and taxi? Now for some family miscellaneous expenses such as: Clothing, shoes, toiletry items $ Recreation and hobbies Gifts and charity (Christmas, church, United Appeal, etc.) 19o (e) (f) 20. (a) Check for m using (b) (c) 196 cont. Books, magazines, etc. Income taxes Subtotal $ Other family living expenses not already covered: Total Annual Living Costs $ There are several ways that a person can use to insure the orderly transfer of his possessions to his heirs. We would like to know what estate transfer methods you are using. Check for will be using Do you have a will? Are any of your assets held on a co-ownership basis with heirs (other than your wife) joint tenants partnership corporation other Have you made any gifts to heirs for the purpose of reducing estate taxes? Have you sold any property to heirs for the purpose of reducing estate taxes? Do you have any kind of trust arrangement? Are there any of these estate transfer methods not being used now which will definitely be used in the future? ( Check on right above) Do you carry life insurance now? No Yes What is the face value of your life insurance coverage? 20. 21. 22. (e) (a) (b) (e) (a) 19? cont. What type of policy do you have? Term Ordinary life Limited pay life Endowment When did you take this policy out? Year 19 0 There are several things that a person can do with money that he doesn't need for his day-to-day eXpenses. Please consider this list of ways of investing money and tell us which ones you would prefer. (Card 6) (Probe to get three or mgze acceptable alternatives.) Mutual funds Land Bonds Mortgages Land Contracts Common stocks Savings account Which do you consider to be the poorest way of investing your money? . Why? __ __ A 0 Which do you feel is the best way to invest money? Why? We would like to establish a fairly detailed estimate of your net worth. As I read the fol- lowing list of assets, please provide your best estimate of the market values of those which you have. In cases where ownership is shared with someone (other than your wife), we would like the value of your share. Valge Farmland and buildings $ Livestock Farm machinery and equipment Feed, crops, and supplies on hand Securities-~common stocks mutual fund shares bonds and debentures annuities Bank savings accounts, saving certificates, etc. ~~savings and loan associations 198 22. (a) cont. Money owed to you: farm mortgages $ farm land contracts other mortgages and contracts notes other money owed to you Cash on hand and in checking accounts Nonfarm real estate--dwelling --other Personal possessions (household, auto, BtCe Other assets (describe) Total Assets $ (b) Now, we would like to know the approximate amount of your financial obligations. Do you have any... Real estate debt $ Short-term notes Accounts Payable Household or auto installment debts Other debts Total Obligations $ NET WORTH $ 1 Interviewer's Remarks: (Observed level of living, condition of home and furnishings, and any other relevant comments about respon- dent's situation.) "‘MMM