An Investment Requiem


Our investment posts have come to a natural break point. In 2011, I began writing about investments in retirement, and some days ago I posted a piece describing how much young workers need to save for retirement. Let’s review and celebrate ideas about investing.

The Main Points

The story began by emphasizing how easy it is to risk retirement for a loved one by spending retirement money on family and friends. The risk arises from the simple fact that when a retiree spends part of a portfolio he thereby diminishes future earning capacity—it is the portfolio that earns income. There are other ways of offering responsible help.

The six-step model came next, introducing my version of the 4% rule: withdraw 4% of an initial portfolio for retirement income, but don’t take automatic inflation adjustments in succeeding years. The model worked pretty well from 2000 to 2011 using only two mutual funds, and it worked even better as we diversified the portfolio to reflect the entire domestic stock market, REITs, and international stocks.

I interrupted that story with other posts showing how different a portfolio behaves during retirement when it’s supporting withdrawals. Switching from annual savings during work to annual withdrawals (4% of initial value) in retirement greatly dims the prospects for further accumulation. That story emphasizes again how important it is to be prudent in retirement.

Other posts covered rebalancing a portfolio and helping family. One great way to help children is to set aside part of a parents’ portfolio for a child’s retirement. With the “great recession” of the last 5 years, many young people haven’t been able to begin saving for their own retirement. Parents who can afford it might help fill that gap. In general, given the declines in American wealth and income, families may very well want to rethink traditional trajectories in which everyone becomes independent. A family model more like recent immigrants, in which members join in mutual support and cooperation for years to come, may be appropriate to modern times.

New England 2011_135One key post introduced Alice, a model retiree. She retired at the beginning of 2000 with $300,000 invested in the same way recommended in the international stock post. Alice used our 4% rule and managed her portfolio for 11 years, ending the period with 36% more money than at the beginning. Then she withdrew money for the upcoming year and still had 32% more. More recently, we checked back on Alice to see how she did at the end of 2012. She was 48% ahead of her initial $300,000—2012 was a very good year. This most recent 12-year period is sometimes thought to have been disastrous for retirees, but Alice did fine.

I wrote a series of posts arguing for self-managed, passive investing. Who Wins, lays out a basic logic for passive investing developed by William F. Sharpe, a Nobel economics winner. I quantified the difference between active and passive investing for a portfolio like Alice’s. Then I pointed out some characteristics of active investing that can be costly for retirees (and others). One of the principal reasons that passive investing works so well is that short-term securities prices tend to move randomly. An investor can buy and hold a well diversified portfolio of stocks and bonds through low-cost mutual funds and do better than the great majority of active investors. That is an amazing result, and it’s backed up by years of serious, objective research.

Another group of posts (1) highlighted Merrill-Edge, a firm hoping to serve middle income investors, (2) argued that investing is like driving a car, and (3) that more and more investors are adopting versions of self-management.

Finally, I developed ideas for our children, hoping that we can help them prepare for their own retirement. The posts began by setting some savings goals and discussed that fixed annuities may have a role to play in retirement planning. A person can buy an annuity to provide an annual retirement income that is greater than what our 4% rule will offer, but of course there is no money left for heirs and no opportunity for flexible retirement spending.

In the last two posts, I showed how Social Security influences retirement goals and how much money young people might save each year to provide for their retirement. Social Security provides a large share of preretirement income for modestly paid workers, but it provides a small share for well-paid workers. Over 40 years, a modestly paid worker can accumulate enough for retirement saving less than 10% per year, but well-paid workers, especially those who expect significant increases in real incomes during their careers, will need to save considerably more. It approaches 20% for some.

Towards a New Emphasis

We—you and I—have told our kids how to save; we have seen low-cost, passive investment work out well; and we have worked through the mechanics of self-managing a diverse, balanced portfolio in retirement. For now, that’s enough.

I may write more on investments in the months ahead, but one goal is accomplished. We have a story that hangs together and offers help to retirees and their kids. Money and investments aren’t the end-all in life, but they need to be well managed to allow people to step aside and live more fully. A man or woman who is always behind a financial eight-ball, it seems to me, is never far from the debilitating effects of worry, assuming the person isn’t in denial. And denial is like delusion.

I’m now thinking of winter and summer, travel, motorcycles, family, photography, and some good literature. We should set the accounts aside and wander a little around other areas of life.