If you rely on personal assets for your retirement lifestyle, nothing will matter much more to you than the path your investment yield takes.
Investment yield is 7% each year. Inflation is 2% each year. Any yield or loss is taxed or refunded at 25% and spending in the first year is $50,000.
If you start with $1,100,000 and the above assumptions, the capital after 20 years will be virtually unchanged. $1,066,000 20 years later.
The real world is volatile.
That affects outcomes and consequentially security.
Make the same assumptions as above except, the yield is not a constant 7%, but rather the yield produced by the S&P 500 Total Return Index less 2%. We will find things are quite different.
- Retire in 1990. Average yield is 7.26% and value after 20 years is $1,200,000+
- Retire in 1995. Average yield is 8.8% and value after 20 years is $1,700,000
- Retire in 2000. Average yield is 3.8% to the end of the 17th year (as far as we have data) and the balance then is $305,360. About 4 years’ spending.
- Retiring in 1990 involved a relatively benign market. The first year endured a small loss, followed by a 30% gain. The next three averaged around 6%. Capital after 5 years grew to a little over $1.2 million.
- Retiring in 1995 was exhilarating. The worst year in the first five was make 17%. Capital more than doubled in five year despite the spending.
- Retiring in 2000 likely caused some heart attacks. The first three years were all substantially negative. Capital fell to $611,000. Year four was good and year five was over 8%. Nonetheless capital was just $669,000 after 5 years.
The five year result for 2000 retirees assumes they did not cash out before the end of year three. Looking from a great distance, maybe not, but in the real world, a great many did. They missed the 28% yield in 2003.
Averages tell you little.
Even if you think they will prevail, the order of events making them up always matters.
The average flaw
Averages in the stock market only happen if you have no liquidity demand. People who rely on the market to produce income will find that liquidity needs create very negative effects when the market goes south in the early years.
The defense is to maintain enough liquidity outside the market to deal with liquidity in the near term. That is a form of diversifying that relates to your needs and time, rather than various market sectors.
In my experience clients understand that perspective better than diversified asset management.
Retiring in 2000 was financially deadly
You might have survived the early years with a large liquidity pool and a smaller market exposure, but 2008 would have put the end to that story. No matter how much we think the future will be like the past on average, we can expect to find situations that won’t work. Some one who retired in 1995 would have found it foolproof, but that said little of value to the person retiring in 2000.
People make poor decisions when they are stressed. I know a former accounting firm client who when he sold his business in 1988 had enough to live comfortably so long as interest rates were above 10%. Bank deposits turned out to be a bad investment for him when rates dropped to 6%.
An easy solution. Invest half your capital in “guaranteed notes” to yield 20%. Not so good when the capital disappeared too. Goodbye home. Goodbye cottage.
Life should be easier, but it isn’t
Every plan should assess the negative side. If you don’t know how you would get along in adversity, you are not yet done.
Consider shedding risk to others. Annuities look foolish on a yield basis, but not so crazy on an after tax cash flow basis. Especially when the market is down 30% or more.
Try to see money as how to get what you need. If you live the life you want, it does not matter how much is left at the end. Despite what American Express says, their traveler’s checks are not good everywhere. You cannot take your money with you.
Decide your real priorities. Portfolio balance may not be a good indicator of success.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.
In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. email@example.com 866-285-7772