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Retirement Planning

Don’t let this mistake ruin your retirement

Recently, while enjoying a holiday party, a friend was talking to me about her plans for retirement, in hopes, naturally, of getting some free advice. I’m always happy to help out my friends, but the advice I gave was not quite what she had expected to hear.

 Helen is a single nurse in her mid-60s. She said to me, “I have $300,000 in my 403(b) retirement account, and I have to have an annual income of around $25,000 a year in addition to my Social Security. I ought to be OK if I take out that amount every year, shouldn’t I?”

 Doing the arithmetic in my head, I quickly realized that she would be withdrawing from her retirement account at a rate of over eight percent per year. What was my response? “At the rate you’re proposing, you will probably run out of money during your lifetime, most likely when you reach your 80’s. I understand you’re healthy, and that there is a very good chance you might even live well into your 90s. You will be better off by beginning with a more moderate withdrawal rate of only four percent per year, and then, down the road, if your investments do well you could increase your withdrawals at that time. This would mean you should start out by withdrawing only $12,000 per year.”

 And her response? “No way I can live on $12,000 per year!”

 I went on to say, “If you live into your 80s and deplete your retirement savings, then you will end up living on just your Social Security. So you must consider your retirement account as a kind of generator of lifetime retirement income and conclude how much income will be reasonable to expect from your savings.” I encouraged her to learn more and suggested she check her local library for books on managing her own retirement income.

 Helen’s story, unfortunately, is all too typical of the kind of financial “planning” so many people do for their retirement years. They generally estimate the amount of money they should need each year for total living expenses, over and above their Social Security income. If theretirement savings they have put aside are somewhat bigger than this annual amount, then they believe they will be fine.

 

Using Debt to Fight Inflation: If You Can’t Beat Them…

So last week we covered TIPS, a way to protect yourself against inflation in a no-risk, no-reward, but-at-least-not-sinking fashion, which is perfect for those who are getting close to retirement.

This week, we cover a totally different approach.  The way to not just keep up with inflation, but to turn it into something that works for you, not against you.

First, let’s ask ourselves again, why does inflation occur in the first place?

Governments spending more than they take in, creating debts which require the additional printing of money to pay back.  When they print more USD without adding value to the assets that USD holds, it reduces the value of USD that was already in existence.  They are intentionally using inflation to “pay” (shrink) their debts by removing value from the assets you and I own. 

So what does this mean for the gov’t?  They borrow $1000 in 2018 with a promise to pay $1,020 in 2019, but pay it back with currency that is only worth $980 by 2018 standards.  And they’re doing it in a way that the average joe does not understand, and thus, won’t get any negative feedback in the way that raising taxes would.    Why would they ever stop?

So not only do we know how inflation works, we also know that people in power have a very vested interest in keeping the little shell game up.  It’s not going to be changing anytime soon.  Unless gov’ts all of a sudden decide that they’d rather run balanced budgets.  I’m not holding my breath on that one, are you?

But wait… if it shrinks their debt… doesn’t that work for us, too?

You bet your ass it does.

That is the one single reason most baby boomers will manage to have a healthy retirement.  Not because of the value of their retirement savings, but because of the value of their debts like their house loans literally melted away in the early 80′s.   Say you bought a house in 1977, with an 8% interest rate.  But in 1980, inflation hit 16%!  That means that as the value of the money someone was making their mortgage payment with shrunk by 16% in one year.  In fact, within a six year stretch, the real-world value of their debt had shrunk by half before we even took the payments themselves into account!  

A $300 mortgage payment was a hell of a lot bigger in ’77 than it was in ’83.    And during that period, the value of the house itself increased along with inflation as well.  Not as high as the rate of inflation… real estate prices didn’t increase by 16% in 1980, but it was 8-10%.  Add that on to the debt shrinkage, and you have some serious damn value creation!  So much so that many smaller savings and loans either required bailouts in the early 80′s or went under entirely.  That money went somewhere alright… right into baby boomer mortgageholder’s pockets!

But there’s still one problem.  We have to pay more interest to borrow money than a government does.  While real interest rates (interest minus inflation) is negative for governments, it’s still positive for us, which means we’re losing value on the debt.   ex.   3% inflation a year isn’t going to do much against a 23% credit card interest rate. 

But, if we buy something that appreciates faster than inflation, we can add that onto the total, giving us a net profit!    Think of it like this.  Let’s (in our dreams), buy a Picasso.  Say we get a loan for $1,000,000 and put down $250,000 to do it.   (Cheap Picasso… was it a sketch on a bar napkin or something?)   And unlike the gov’t, which is getting it’s loans for 2% (or less!) We have to pay 3% or more based on the length of the loan.  Let’s say we’re paying 4%.

But, the value of the painting is going up an average of 4% in nominal dollar terms every year as well.  So we’re breaking even.

But if, for some, strange reason, inflation spikes because, say some gov’t debt goes through the roof and goes above 4%, we actually start making money because the value of the dollars the debt is in is shrinking!  And our 4% apprecation?  Well, the reason that painting’s dollar value is going up is not just because fine art becomes rarer over time… it’s also going up because the value of the dollar is shrinking.  And if that value starts to shrink faster, the “appreciation” goes right along with it!   

Let’s say that the time of inflation reckoning is year one (it won’t be, but for the sake of easy math) of 10% inflation.  You paid 4% interest, but the value of your debt shrunk 10%, and the value of the painting went up 8%!  We mostly kept up with inflation in our re-sale value, but we actually lost 2% of it’s value.  But our debt lost 10% of it’s value!  In inflation-adjusted terms, we made (-4% of $1m, -2% of $1.25m, +10% of $1m) $35,000 of post inflation value ($60,000 pre-inflation) on an investment of $250,000!  That’s 24% pre or 14% post inflation cash on cash!

Of course, don’t run out and buy a painting.  There’s all sorts of transaction and maintenence costs we’ve neglected, and how do you sell a painting, anyways?   And the value of art will go up and down independant of inflation due to other market pressures, the same as any other asset does.  (ask American homeowners about their houses)

But the principle remains.   Find something that you are very sure will appreciate at least as fast as your interest rate.     Get a rate of interest if not below inflation (damn near impossible),  as close to it as possible.   As long as the appreciation plus debt shrinkage is high enough above the interest rate to offset the risks and expenses of being in that asset, you are making value!

 

Treasury Inflation Protected Securities

Last week we promised you a single, and here it is.  This investment is a back-up for the fixed-income section of your portfolio, the portion that is traditionally exists to reduce volitility, which you need more and more of the closer you get to retirement.   When you’re 28, the 2008 market crash was a blip on the radar, but when you’re 64, it’s devestating.   

But that reduction in volitility comes at a price.   Traditionally, your fixed-income securities carry a significant portion of inflation risk in that if you receive a 2% return over the course of a year, but that year brought with it 3% inflation, your investment actually went down in value.

But not with Treasury Inflation Protected Securities, or TIPS.

TIPS are a type of fixed-income investment that carry two types of income.  The first, the normal interest rate you expect to find with any traditional bond.  The second, and key type, is that the principal value of the bond increases with inflation based on the consumer price index.

For example, let’s say you bought a $10,000 bond with a 2% interest rate.   Now, for the sake of easy math, let’s say that inflation had a early-80s kind of spike and came in at 10%.   The value of your TIPS increases from $10,000 to $11,000 to compensate for the loss of dollar value (something you wouldn’t get with a traditional security).  Then, you get your interest rate paid out on that amount.  In this case, that would be $22, instead of the $20 you would have gotten off of the $10,000 value.

They can be purchased directly from the Treasury, a broker, or through a mutual fund or ETF.

It doesn’t offer much from the perspective portfolio growth, but it is the only investment gauranteed by the US gov’t to provide you with a post-inflation positive return.  And for those of us who need to be dialling down the risk in their portfolios, that’s a great place to start.

Making Retirement Work Tip #4: Don’t Get Attached to “Stuff”.

One thing I learned about moving to Mexico was how little I actually needed to happily live life. When I came down here two years ago, I came with clothes and a laptop. I rented a furnished apartment, hung up my clothes, and voila! Home. I have since got a comfortable office chair and a monitor for my laptop, but that’s really about it in 2 years. When I return north, I find myself in awe of how much useless stuff I have squirrelled away that I don’t think about at all while I’m gone.

All that stuff was bought somewhere, sometime. And the vast majority of it, I now realize, was totally unnecessary.

Decorative samurai swords for my wall are not making me happy. The just make points with people who judge others based on the stuff on their walls. (which is who, exactly?)  A fancy glass-topped kitchen table does not make my life more fun. My girlfriend makes me happier. Shooting the shit with my friends while taste testing a bunch of foreign beers from the local import store makes my life more fun.

Cheaper, too.

It pays to identify what are things that improve your enjoyment of life, and things that either make us less happy or don’t impact it one way or the other. And if it’s not a necessity, and it’s not increasing our enjoyment of life… what’s the point of buying it? That simple shift in attitude alone can save hundreds a month.

Making Retirement Work Tip #3: Get Outta Dodge!

Let’s face it, most of the ”Developed, Western” world is a pretty expensive place to live. Sure, it’s balanced out by some of the highest wage rates in the world, but what if you’re not taking in the wages anymore? Are you still living in a place that requires you to pay out the heightened expenses?

I’ve had the opportunity to experience and take advantage of this first hand. As an aspiring poker pro, I make money every month, but not nearly enough to live on. (Hence the word “aspiring”.) But since that doesn’t actually require me to live anywhere in particular, I decided to move somewhere a lot warmer and a lot cheaper, so I moved to Mexico.

So I put my small town house up for rent and used the income to rent a 800 sqft apartment in a gated community. My expenses are only somewhere around $1100 a month. I have friends here that aren’t quite as rambuncious as I am (read: cheap drunks) that live fulfilling lives on half that.

Not to say that you can follow my lead if you’re like most people and working a job that requires your physical prescence… but when you stop? Think about it. And if you’re not tied down to one place already…. what are you waiting for?

Imagine this. You’re 65. You want out of the rat race, but you only have 300k in the bank. For all you know, you might live another 30 years, and assuming you spend 20k a year (which is a pittance in most parts of America), that’s only 15 years worth of living. Before inflation. But living in Mexico or someplace else that only requires 7-10k a year? Now things are looking up!

But aren’t developing nations dangerous?   Well, it depends on what you view as dangerous.  New Orleans averages a murder a day for a little over a million people.   The town where I live that’s 1/10th the size?  3 last year, I believe.  And that’s in “the drug war”.  Plus, because public transit is so cheap, (a bus is 40 cents, a taxi ride 3 dollars) I don’t even need a car, and the speed limit in town is less than 30 mph.  Which virtually eliminates my odds of getting in a deadly car accident, which statistically speaking is waaaaaaay more likely than getting killed in an act of violence.

There are sizeable ex-patriate communities all over the world.  And since ex-pats pick where they live, as opposed to most locals that just grow up where they were born, they tend not to pick places where street crime (the only kind that effects you unless you plan on joining a gang or something) is rampant.

So go ahead, do a little research. Take a trip or two, check it out.  Explore.  Not only will you save some cash, you’ll broaden your mind.