Value Is In The Using

Is a possession you do not use of any value?

  1. Knowledge is of no value unless you put it into practice. Anton Chekov
  2. A man who does not read has no appreciable advantage over the man who cannot read. Attributed to Mark Twain and several others.
  3. Everyone should put several $100,000,000 aside for a rainy day. Henry Ford, 1928
  4. You can live as well with $4 billion as you can with $12 billion. Craig McCaw

I think Henry Ford and Craig McCaw may live in different financial realms than I. Nonetheless I can understand their point. If you are wealthy enough, you only need some of the money you have to live as you wish.

What is the rest of the money for? Beware! A great deal of money is wasted because it does nothing. It is like potential energy, waiting for a purpose. No more useful than a battery in a drawer.

Maybe it is waiting for an opportunity, perhaps it is accumulating for a future acquisition, either business or personal, or maybe for a future expense like education or merely for security. For some, it is just there.

Financial security is nice but at what level? The more you have to look after, the more time and brain space is consumed in doing so. Perhaps the hermits and mystics have it right. Need less, have less, and use your resources to achieve only what you value. I am not sure I can do that, but I think there are a great many people who have, and have lived complete lives in the doing.

An analogy. If gardening becomes burdensome or takes time away from important things, reduce the size of the garden. Pretty obvious.

But what about security? How could you have too much? Better how much do you need and what could be done with the excess?

No one really knows how much. It is a little like tidying up your office. What should you throw away? The things you don’t need, right? But which are they?

With security, the first step is to define what the word means for you. For most people the intuitive idea of security is that the future is predictable and controlled within some margin of error.

There are several security issues to address:

  1. An event might happen and would be adverse financially if it happened. Something I don’t want to do or have. Medical emergency is first on the list. Automobile accident with a claim over the limit, child needs help, parents need help and more.
  2. Something that produces or will produce income for me that stops or reduces. An employer pension or a government benefit. Government benefits are not promises they intend to keep at any cost. These are things they will do if it remains expedient. If not, they will amend the rules. Some employers are not going to be able to pay what has been promised.
  3. One partner dies and the remaining pension income to the survivor is less.
  4. Income from investments may be different than expected. For those that retired in 1990 expecting to get 10% on government bonds life has been interesting.
  5. Capital can be irretrievably lost. Bernie Madoff comes to mind but weak investment decisions, especially ones made to overcome the lower interest rate environment are there too.
  6. Inflation and the tax system could be such that the after tax yield on investments is negative. You erode real capital each year even if the nominal capital looks to remain intact.
  7. Your spending on lifestyle may be more than you thought.All of these presuppose you know what your preferred cost of living looks like and you know how it will change. Not many actual know this. Guessing is common. Pay attention to the fact that as you age you lifestyle choices change too. Experience shows that beyond about age 80 lifestyle spending falls and inflation may be a non-issue.
  8. Yield fluctuates widely and you are drawing money. Early adverse swings may not affect the average yield over 30 years but they will affect you because your draws reduced your capital.

Knowledge is a part of the defense to margin for error. If you know enough about the dimensions of the possibilities, and have insured some of them, (shrinking the garden) then you can get a clearer idea of needs. You may need to do some research.

Facts trump assumptions.

You can model the capital that underlies the cash flow required to fund your life style for decades into the future and you should do it. You should probably do it under several contingencies.

  • Everything turns out like I hope
  • The after tax spread between yield and inflation is adverse
  • Seriously adverse
  • Spending is higher and I cannot reduce it
  • A significant capital consuming event or loss occurs early on. It won’t have as much effect later.

What you will find is the capital needed to make your cash flow work. First the minimum; everything turns out as expected or better. After many trials, the worst, with the others between.

At the beginning you will need to see the capital that supports the worst case safely in your possession. If you revisit it every 5 years or so, the amount will shrink even with the same adverse assumptions, because your time of using it grows shorter.

Whatever you have in excess of this “minimum margin of error” fund is dead money. You will almost certainly never use it. If you spend any time or effort looking after it, it is practically, for you at least, a liability.

Like the Twain quote above, slightly amended.

A man who does not use his money has no appreciable advantage over the man who has none.

You might find this interesting. Stewardship

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Follow on Twitter @DonShaughnessy

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