EclectEcon Will the Nominal Rate of Interest Be 9% in the Foreseeable Future?

Former student Ravi sent me this item about Tiger Woods' possible pension funds. It asserts, in part,

If Woods keeps winning at his current rate, enjoys a nine percent annual return and captures just seven FedEx Cups in his career, he could reach $1 billion in retirement payouts courtesy of the PGA Tour Inc.

Nine percent? NINE PERCENT??? Using the Fisher Equation (named for its discoverer, Professor Equation), that means (assuming a real rate of interest of about 3%) that they think the expected rate of inflation will be about 6% over the rest of Tiger Woods' career. I don't really know of many people who expect the rate of inflation to be that high, and the money markets certainly imply a much lower expected rate of inflation with long-term nominal rates down around 5% or so.

What kind of risk do they assume Tiger Woods is willing to assume to get that kind of return? Are they thinking he will place his entire nest egg in sub-prime mortgages (I gather many are available cheap these days)? Or did they just keep messing with different interest rates until they found one that yielded the desired results?

(link)

William Polley (mail) (www):

9% is a tad high perhaps. 7.78% would be appropriate if he was in a stock index fund, according to this.

No reason for him to be in a money market at his age though, at least not entirely. I would expect that Tiger would hire someone to be a little aggressive with at least part of his portfolio, meaning he might do a little better than the 7.78% average on the S&P.

Personally, when I run hypotheticals on my own retirement, I run it three ways, at 6% (lousy market), 8% (doin' ok), and 10% (the stars aligned in my favor). And then adjust for inflation of around 3%.

9.24.2007 3:38pm

Tom Hanna (mail) (www):

My guess is that anyone with sufficient capital to make a serious, diversified buy of subprime securities today would probably do a lot better than a 9% return. Assuming a 20% foreclosure rate with 50% losses on each foreclosure (where you're often talking about 70% loan-to-value loans to start with), you're really only talking about a a 10% discount off face value. And many subprime mortgages were north of 9% interest rates. Since subprime securities mostly just aren't trading at all finding some at a more than 10% discount ought to be doable. There are probably a lot worse places Tiger could put the portion of his money he's willing to take a bigger risk with, if he can find an advisor as good at putting the deal together as he is at playing golf.

9.24.2007 5:58pm

EclectEcon

Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre A View from/of the Econochasm by John Palmer

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