How to not get ripped off in retirement reminds me of the classic Monty Python skit on “How not to be seen.” The first step in not getting ripped off is to not give your money away.
Years ago my Mother sought my advice, one of only a handful of times she did, and I told her the investment she was getting into, along with many of her friends, was dangerous, that, unlike her friends who had far less capital to risk, she didn’t need the “guaranteed” high rate of return. All she really needed to do to have a happy retirement and outlive her money was to protect her existing capital and not worry about growing her net worth any more than it already was. She invested anyway, just a small amount she said, because the return was so good, and her friends went on and on how great it was. Something in her just couldn’t stand the idea of a modest, low risk, return.
It was a Ponzi scheme of course and she lost the majority of the capital she invested. It also turned out that she kept adding money to it so that in the end the loss was, while not crippling, substantial. Her friends, of course, were devastated as for some of them it was the majority of their retirement income… Many “invested” their life savings. Thus the first lesson on how not to be ripped off is, if it seems too good, it is.
If a person knows how to win the lottery, every time, then they have no need to sell you their brilliant idea on how to win the lottery… duh. If you think it through… well, just why would someone who can win millions at will need five bucks from me? So please consider, in the investment world, if someone can get a bank loan at three percent, why would they want your investment money that they promise to pay back at eight… or ten? Guaranteed. How is that any different from the “How to win the lottery” scams? The answer is that it is either the investment is too risky for a loan, or they aren’t worried about the interest rate because they never had any intention of paying you back in the first place.
This seems odd to those (even) older than myself who remember the days of ten percent bank CD’s… well good for you and I hope you got your money back then cause a rate higher than a percent or two, backed by a named FDIC insured bank with tons of assets, isn’t even visible in the rear-view mirror anymore.
Reality insists that return follows risk. In that sense, profit is the price of risk. Just one more time, investing is when you buy someone’s else’s risk… The more risk the higher the promised return needs to be in order to cover the likelihood of the loss of principle. If, like my mom, your need is just to preserve principle, then it’s time to be very conservative and ignore the interest. Be happy with what you have because if you have enough, then you likely have a lot more than most.
This doesn’t mean that low risk, high yield investments don’t exist. It just means that “they” tend to get the yield and “you” tend to get the risk. Consider the “Reverse Mortgage” industry. You are putting up your house, a real solid and tangible asset, for what is nothing other than a loan. If you are old, wish to stay in your home a few more years, and don’t care to return any capital to your heirs this may not be a bad thing… But to retire early, pop out all your equity at age sixty-two with all the front loaded fees involved… The bank gets upwards of five grand up front just for doing the paperwork, which you then spend the next thirty to forty years paying interest on… excuse me while I clean the vomit off my keyboard… all for the privilege of having a big pot of equity that if you spend will only increase the interest payments on the loan to the point where it quickly drains all value… leaving you destitute right when you really do need a last minute infusion of cash. Like when you are a lot closer to dying than you are right now.
No, you are better off holding onto your equity until you really are ready to sell your home, then it could be a sale or a loan, it doesn’t matter since you won’t live long enough to repay it. Use that cash to live it up your last five or ten years and don’t forget to rub the kids noses in their not getting anything from you when you kick…
The reversal of risk and reward also seems to me to be the basis of the “Annuity” and “Whole Life” scams. Their money really is guaranteed, paid up front from your life savings to them, after which a surprising number of them go bankrupt, don’t or stop paying out. The question for you to ask yourself is who exactly is doing the guaranteeing of what. My uncle invested in “Life Partners Viatical.” The link, for those interested goes to the bankruptcy statement of the trustee. The current fire sale value is three cents on the dollar. If you are dealing with, or going to deal with an estate matter in the future do not be surprised to find among a loved one’s assets one or more of these non-performing instruments of doom.
So, what does that leave for someone with money to invest and who is young enough still to require a modest return to avoid running out of cash before shuffling off to Babylon? Like me.
Well if you are like me, and feel OK with carefully weighed market risks, then you can keep your money working for you in the market while realizing that you are owning risk… that is what they are paying you for. If you sweat every twist and turn of the market, or worse, try to play it, well there is still your social security money. Try to make a plan to live on that… or consider the life of a Wall-Mart greeter. Really, it’s honest work and you can make fifteen and change before any social security penalties.
So how much risk? I feel comfortable with a six to seven percent return overall, an emphasis on long term dividend payers with a history of paying because they can turn that capital into greater than seven percent profit for themselves. I could easily lose as much as half my invested principle despite that, but if I buy and hold, ride out the storm, it will likely come back in a year or two. Of course only two or three percent of that roughly seven is returned for me to live on, but I can start diving into capital someday…
Speaking of which, the old rule of thumb was to mix stocks and bonds, and follow something they called the 4% rule. If you withdraw 4% of your capital the first year of retirement, then add in inflation to subsequent years, your money will last at least thirty years. Problem is that doesn’t account for an early market downturn. A steep enough drop early enough will hurt… badly. A contrarian idea, and I am nothing if not an instinctive contrarian, is to take the two to three percent dividend return early on (which is why I am mostly moving to dividend funds these days) and only cashing out one or two percent of principle gains, as late as possible, if at all. A widely distributed index dividend fund with low fees, like one of the Vanguard funds, should gain value faster than inflation while paying out a modest income. Later in retirement, if needed, I will add spending money by starting to cash in principle using something less than the old four percent rule.
In my case I call it the three by three rule… take on some individual higher risks, like Cedar Fair (FUN) in my case, to pump up my dividend return so that combined with the lower risk funds I average closer to three percent than two. Then realize that I can take out as much as three percent of principle on a year with good returns, and bank it for future spending money. Then if I have to weather a big drop, I still feel comfortable that the value will return over a year, two at most, which should work out if I continue to be certain to keep some cash on hand to go with the dividends and social security. Any year with a nice up trend that I don’t cash anything out of is like buying myself a future raise, if I cash up to three percent out, then it is like buying an insurance policy against having to cash out during a downturn. When it drops, and it will, leave it be and just economize. Get off your lazy behind and do some work, cancel a planned vacation, whatever, just don’t withdraw capital during a market downturn.
Of course this plan will, I believe, work for me, because it fits my personality. On the other hand it would have driven my mother to drink. And that is the real bottom line. You need to come up with a plan that works for you. One that you believe in and which fits your own personality. Of course if your personality is, like all too many, Yippee… I have money in the bank what can I spend it on… then the most I can do for you is to wave back whenever I go to Wall-Mart.
Thirty Times Around 