Increase Risk as You Age?

So, what happens when you get this $300 a week, and a Big Mac costs $24 by then? I see inflation as the big issue in this plan. Doing "safe" investing has a hard time keeping ahead of inflation, so you say even or even lose buying power over time. You need the gains from better returning investments to outpace inflation so you get some real growth over time. Once you have this growth, then you can back off and go into maintenance mode.

-john-

How can you have a safe income from dividends, without owning stocks or preferred stocks?

It is not a bad idea. As you have more and more money, you can relax your cash requirement. The exact amount of cash that you need to save depends on your monthly expenses.

i

At this point I feel certain economic statistics parallel those circa the Great Depression. I think it is a good lesson to review what happened to dividends back then. Just as something to consider and maybe help round out one's finance education. Using Robert Shiller's S&P 500 data, in 1930 dividends were at a historical high. In the next five years they declined by about 50%. They did not return to their previous high until 1949.

I understand the S&P 500's dividend is down about 10% from a year ago. This is mostly due to financials cutting dividends. The net reports that many non-financials are so far doing fine and expect to increase dividends in 2009. But I have my doubts based on other economic parameters (unemployment; the necessity of revamping the financial system leading to the slowing down of lending leading to less growth blah blah). I personally am planning for a rough few years, maybe more, for dividends. The one advantage we have today over the 1930s is that presumably our elected officials know something about what seemed to worked in the 1930s. Yet I am not optimistic. The U.S. economy is particularly sick in my estimation because of an out-of-control health care system, fueled by consumers' know-nothing mentality on same.

By contrast, in the 1970s, dividends rose rather steadily, despite the flat market. IMO this will not be the 1970s.

I have an elderly neighbor friend who has been investing for decades and who proposes that history does not repeat itself the way we are all anticipating. Or as one of the regulars here often says, that which is well-anticipated in financial markets rarely actually ends up happening. Yet I continue to have doubts. The decline in stocks was fairly rationally based on a perception that the buildup was a house of cards, due to all the leveraging present in various markets. Demand is falling. These are key to what drove the Depression.

Otherwise, ditto what John said. By failing to invest in the economy via stocks now, you miss years of compounding growth. Investing early in stocks is key, assuming things normalize some in the coming years.

Still, I would not say you or Ignoramus are way off. Consider either

1. Splitting the baby: about 50-50 stocks and high grade bonds/CDs/CD ladder. or
2. Accumulate about seven years of living expenses in cash and a CD ladder. Add to this as your living expenses rise (for whatever reason). Invest the rest in stocks and maybe some bonds.

That represents about a 7% rate of return, which seems overly optimistic

If you do actually save up $220k in your 20s, you will be well ahead of the majority of your contemporaries.

Really? Have you factored in taxes and health care expenses? Marriage and children?

When you are young, your should based your expenses from working wages.

My first impression was $300/week was a high return, and I calculated a yield of 7.1% needed. Exactly which bonds will generate this 7% over a long period of time?

The premise of the original post is accurate based on my experience. I have found that once I accumulated a substantial amount (200k) I was willing to take risks I had not considered with a PORTION of what I was invested. For me that was about 10% of total assets and 25% of new money. Ironically my wife's Roth was 10% of our portfolio at one point and it's also 25% of our new contributions each year.

At same time I increased the risk profile in wife's Roth, I also lowered the risk profile in some other accounts (shifted from 100% equity to 90-10 for example, and moving to 80-20 or 60-40 once the market gives us some profits).

I would suggest that even though I'd not predict the next 1yr, nor 5, that stocks will exceed cash/bonds over the next 20 years. We don't know your current balance nor rate of savings, but given the choice between (A) saving nearly 100% in stocks* for the next 20 years, then paring down, so a crisis as we are in today will only have you with maybe

40-50% stocks at age 45-50. (B) starting with cash only today, and simply not investing in stocks till age 35 or 40.

I'd pick (A). The *note in (A) is to be clear that you still need to choose wisely, this thread not addressing actual investments within that universe, and that an emergency fund is still suggested, separate from the investments.

I am mid-40s and despite the present scenario, I have no regrets about being full up in stocks, having done so since I starting working. (now, my 80yr old client who is less than 50% stocks thinks me a genius with her friends down 35-40% and she, only down about 15% in 2008.)

Joe

US Government bonds pay little interest, you need something else in your portfolio.

You need investing experience so the earlier you start, the better. You just need to be diversified.

You might want to keep your tax deferred accounts small at first so that you will have funds available for a home down payment, education, or other urgent expenditures.

-- Ron

That assumes a yield of a bit over 7%. Government bonds right now are paying about 2.3% (on a ten-year note).

You can't get 7% right now without assuming substantial risk.

There's an investment-grade corporate bond ETF - with an average bond maturity of about 12 yrs (and a 7yr duration - therefore substantial interest-rate risk, though really no more interest rate risk than those 10 year treasuries), paying about 6% right now. Of course, about 30% of that ETF is invested in banks. But banks' debt is a much safer bet than their equity right now and the dividends on that debt is vastly safer than the dividends on their stock.

So there you go - 6% yield and, while not save as, say, TIPS, a lot safer than equities.

Factor in that you have long-term needs and will need to reinvest some substantial portion of those dividends in order for your portfolio to keep up with inflation and you still come nowhere near generating the 7% spendable cash you assume you need to live on. More like, after inflation, 2%. A $16000/yr living, in perpetuity and accounting for inflation, requires a good bit more capital than $220,000.

You may have it upside down. Your best hope - over the next

40 years (since you are in your 20s) - to build up that core capital that you'll need for a sustainable income - is probably to take a bit more risk now. Eventually, if you have a big enough capital base that you want to use to guarantee your basic income (probably about 2-3x the size of that $220k), you can invest that capital base conservatively (or even buy an immediate annuity with it) and use any additional capital you accumulate as aggressively as you want. But the question is how long it'll take you to build up that capital base?

How much are you putting away each month? And how is that money currently invested? If you're concerned about the volatility and risks, you can certainly construct a fairly conservative portfolio in which to accumulate that core capital base. But going into government bonds and only government bonds is probably not a great idea. It'll take you that much longer (and/or that much more risk, especially if you use slightly higher yielding but much longer-term treasury bonds) to build up that core nest egg. And if you do take very little risk and it takes most of that 40 years to build up that core, you're losing out on one of the most valuable things you have at your disposal for dealing with risk - time.

That is a good point. The way to fix this problem is to invest not just in government bonds but also in shares, but to bias shares towards those that produce reliable income from dividends.

Exactly what to invest in is uncertain, but my main thesis is that an individual should aim to be safe first before increasing risk. The conventional advice by financial advisers that you should decreasing risk as you age exposes you to negative shocks that can hit when you are young, e.g. an economic depression, unemployment, etc. Whether you should take risk or not depends on whether you can afford it.

Someone who earns $10,000 a year should put his wealth into necessities like food and accommodation because he or she cannot afford to put half that money into risky investments. If the investment performs poorly, the poor individual may not have enough to pay for necessities. On the other hand, a wealthy person who earns $100,000 a year can afford to put half his wealth into risky investments. Even if the investments do poorly, he or she should have enough leftover money to eat.

The same logic applies to differences between people of different ages. Someone who is young and starting out in life is poor since he had little time to convert his labor hours into cash. An old man, on the other hand, assuming he has saved up or invested over time, is wealthy and should be able to afford the risk. It makes sense then to increase risk as you age.

Of course, if it takes a long time to save up that $220,000 then this may not be a good idea. I am assuming that you aggressively save up initially.

How much income is needed to cover the necessities is subjective since everyone has a different idea of what is a necessity versus a luxury. But I estimate about $300 to $400 per week. I assume investments can yield between 5 to 10 per cent. It's not perfect, but you shouldn't perform surgery in the sewers just because it's impossible to achieve perfect sterility in the operating room.

Yet, people tend to have more trouble saving in the early years. When getting started, even on good income, the first decade tends toward spending more than saving, and increasing one's lifestyle. As one gets established and enjoys a few raises over the years, the ability to bump savings improves. There's something about your logic which does make sense, from a very conservative viewpoint, but it also assumes that one has that second period in life to invest with more risk. By lowering the risk up front, you've lowered the average rate of return on can expect, and for the percent one can save, that point of safety may extend well past retirement age. Your idea reminds me of Bodie's thesis, investing mostly in TIPS. The real return

is barely 2%, real rate of return. Enter that into any savings calculator or spreadsheet, and see my point.

Joe

Again, to throw off that $300/wk, you need to earn a steady (and inflation adjusted!) 7% if all you've saved is $220k.

The closest you can come to a risk-free inflation adjusted yield is TIPS, currently throwing off about 2% real yield.

If you know of a place to get 5-10% real return without substantial risk, I, for one, would love to hear about it.

Remember that conventional advice also includes maintaining an emergency fund of cash that will cover one's living expenses and any other emergencies (new roof, car, etc.) for 6 mos. to longer.

Rents and dividends are hardly safe income sources. Tenants can leave and dividends can be cut. Bank of America did it yesterday.

As others have pointed out, this is too much income to expect from too little money. Think 4% annual withdrawal. Even that needs about 75% stocks to work for a long time.

If you have good marketable skills, you have a secure basic income. This is one reason for the conventional wisdom. When you're young, you can take more risk because you have this income to fall back on.

-- Doug

Municipal bonds work for those in the higher tax brackets.

Delaying SS gives a high return (7%) for the first year after reaching full retirement age.

Purchasing a lifetime annuity after age 70 gives a good return if you live long enough.

Buying GLD ETF stock and selling calls against it will also give you a return over 10%.

Paying off credit card debt gives a very high rate of return, but in this newsgroup, I don't think anybody has credit card debt.

Insulating a house and other energy conservation measures can give high returns on investment.

-- Ron

Your other suggestions were reasonable, but this one is unfounded. The returns to your GLD covered call suggestion depend crucially on

(1) GLD returns (2) the implied volatility of GLD calls being sold

I don't see how you come up with a return forecast of greater than 10% for this strategy. In general, a covered call stategy compared to simply being long should result in lower volatility, at the expense of lower returns, if options are price fairly.

I don't think you will get significant rates of return on insulating your home, at least for several years. Thumper

"Ron Peterson" wrote

If you live to or long past full retirement age. I evaluated my health and when I would break even. Of course, you can only guess at the COLA. For 2009 it was a 5.8% increase. Not to mention that full retirement age is increasing.

I opted to retire at 62 and my checks for the first year amounted to $15,396.00 and this year I will get $16,284.00 so before assuming a higher return at full retirement age you have to do the catch up math first. It was a while ago so forgive me if I'm off a little. It would take about 20 years to catch up with someone who retired at 62 if you were both still collecting

20 years after you reached full retirement age. I've always been a big big fan of the bird in the hand.

I've got insulation installers coming on Friday. Based on fairly conservative assumptions, I figure a 6 year payback on the investment, which is roughly 16% ROI. -- Doug