Below is an excerpt from the book, Downsize Sooner Than Later – 18 Rules for Retirement Success, available on Amazon.com.
So far, we have discussed the inevitability of ongoing bills and controlling expenses by living intentionally, with an emphasis on lifestyle and routine as keys to retirement success. In this rule, we begin introducing the topics of retirement finances and investing.
I remember, when helping my mother arrange her financial affairs as a senior, she once said to me, “Ted, I just don’t understand financial things.”
I responded in somewhat the same way she used to respond to me when I was frustrated by schoolwork as a child. I said, kindly, but pointedly,
“No. You must not say that. You are a smart and capable person. And you are fully able to learn about and understand the important fundamentals of your finances.”
In the end, she was able to understand, and this deeper knowledge opened the door to a peace of mind which made the effort to acquire the information worthwhile.
Some of what I am about to explain flies in the face of conventional wisdom.
But give it a hearing. I initially struggled to be open to some of these concepts and had to fight with what “everyone else” seemed to be saying, as well.
Conventional wisdom says, “A person should save and invest an entire working career until, one day, he or she can retire and live happily ever after on the funds from an accumulated nest egg.”
The underlying assumption is that income will be withdrawn as needed from the nest egg while, simultaneously, funds not used for current income will be reinvested over time. Following this “portfolio-based” construct, there should be enough funds to afford a happy retirement, along with a generous balance left over for legacy (i.e. money for the next generation and/or for charity).
If you’ve never heard it said before, there are several serious issues with this popular vision.
The biggest issue stems from the fact that because critical underlying funds necessary for future income remain invested, they remain exposed to risk over time. These underlying funds often establish the core of what you will need to achieve long-term security in retirement. If you lose them, you will be in a very difficult situation.
The financial industry is aware of this concern and recommends the remedies of “asset allocation” and “diversification” as mechanisms for safeguarding future nest egg dollars.
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- Asset allocation refers to owning different types or classes of assets as a means of spreading risk. Stocks, bonds, real estate, and commodities are all different asset classes. Theoretically, when one asset class goes down in value, the other asset classes may or may not simultaneously experience similar declines.
- Diversification is the strategy of spreading risk across investments within the same asset class. For example, owning one company’s stock is considered riskier than owning shares in a fund that owns stock in many companies from a variety of industries.
The fundamental difficulty remains that even after re-balancing a nest egg to allegedly “safer” asset classes, these assets are still investments and often pose very real and unique risks of their own. Bonds, for example, are often considered a haven. However, bonds possess the risk of going down in market value as interest rates go up. This is critically important to know, as interest rates hover near historic lows. Where will rates be in 15, 20, or 30 years? If rates go up substantially, how will this impact the underlying value and availability of such funds as sources for reliable income in the future?
Further, just because nest egg dollars are allocated to different asset classes offers no guarantee they will act independently from one another other during a downturn. It is entirely possible that bonds, stocks, and real estate may all decrease in value at the exact same moment in time.
For now, I want you to imagine a different path forward.
With this path, individuals save and invest their entire working careers as before, but when they retire, they split their nest egg into two baskets. The first basket is used to fund income, and the second is set aside to remain invested and undisturbed.
In the coming rules, we will break down in more detail what happens with each basket. The important goal here is to understand that this separation is key and serves two game-changing purposes.
1. Income: The first basket is used to establish guaranteed income to cover basic living expenses. This is income that never runs out, no matter how long you live, and that is not dependent on what happens in future investment markets.
2. Wealth: The second basket is used to establish a fund that stays invested and undisturbed throughout your retirement. Because the funds in this basket are not required to fund income, they are better positioned to ride out future market storms and can more safely benefit from compounded growth.
This simple foundational shift opens the door to solving several major problems in the modern retirement era.
In this blog’s opening story, it would have not only kept James and Patricia from running out of income late in retirement, but, based on historical market records, it would have left them a surplus of millions in invested assets.
Of course, everyone’s circumstances are different and what happened in the past is no guarantee of what will happen in the future. However, success – and failure – leave clues.
The fundamental concept of splitting funds into separate income and wealth baskets can be applied successfully across a wide variety of situations. Whether you have saved a little or a lot, there is substantial opportunity for almost anyone to achieve lasting retirement income security, grow invested savings over time, and acquire greater overall peace of mind.
Questions or comments?
I can be reached at this link – contact Ted Stevenot.