Designing Our Future

Chapter 2

 

Will You Outlive Your Assets?

 

 

 

  As we know, paper money merely represents a value for trade. That value must be acceptable to others in order for the represented value to allow trading of goods and services. Americans look at a one-dollar bill and accept its worth as one dollar. In fact, that dollar may be worth more or less than its face value depending upon where it is traded. Since our money is a representation of value, the actual spending power it has changes frequently, sometimes by the hour.

 

 

Buying Power

 

  There are many reasons why our money has more or less buying power, but one of the most dominant reasons is inflation. Americans are more likely to be aware of the results of inflation than they are the inflation itself. Sometimes our dollars buy less than they do at other times. When the dollar buys less consumers notice although they may not realize the reasons behind the loss in value.

 

  Money is influenced by existing supply and demand. Of course, all of us want to have money, but that does not mean we have the ability to obtain more. Governments have the ability to obtain greater quantities of money: they print it. When governments print too much money they can actually cause the value of their currency to decline.  Therefore, the United States government is very careful when it comes to printing new money. As money wears out it is destroyed and replaced with newly printed currency. Putting additional currency into circulation is done with great care to prevent rising inflation.

 

  In recent years, our inflation has been moderate. That is seldom an accident. More likely, low inflation is the result of careful planning by those who control the flow of money in the United States. Even when inflation is low, however, it never totally leaves us. In fact, we hear so much about the subject that many of us forget the importance it plays in our economic lives. We have accepted inflation to the point that we no longer notice how it financially impacts us. Most Americans know inflation is a negative influence, but few people can explain how it affects our economy and ultimately our personal lives.

 

  Inflation impacts virtually every type of investment in some way, even home-buying and selling. Everything from precious metals to real estate is affected by inflation. Any institution that deals with money is certainly affected. What many consumers may not realize is that inflation can cause businesspeople and investors to pay taxes on phantom earnings. When buying power decreases taxes are paid on income that is not actually there. In other words, we pay taxes on the face value of our money, but it is actually buying less goods and services. We are paying taxes on the face amount of the money rather than the buying ability of it. For those trying to plan their retirement, inflation is the great unknown.

 

 

  The investor must always factor inflation into any equation that involves time. We may have an idea how inflation works, but few of us factor that adequately into our retirement investing. Inflation and interest earnings have lots in common. They work exactly the same way with one very major difference: interest increases our money while inflation decreases it.

 

  Inflation does not play favorites. It affects all types of investments.  Inflation can cause some investments to go up in value, but more often it decreases values. Even real estate can be adversely affected by inflation. This usually happens when pricing becomes over-inflated for one reason or another. When the pricing comes back into line, investors experience a loss. In fact, inflated real estate pricing is considered a form of inflation. Those who invest heavily in real estate know that what goes up may also come down, so they invest in multiple types of real estate to protect themselves from deflated markets.

 

 

The Federal Reserve

 

  The Federal Reserve manages the creation of our money, but those in power often benefit when additional money is printed because it causes the illusion of prosperity. That is why neither the Congress nor the President has any control over such a decision. Even so, the Federal Reserve has been known to be cooperative with those in power. The Federal Reserve’s power comes from Congress. Its board is made up of governors. Some have questioned whether this was a wise choice since the governors may have future goals for themselves that could be benefited by their willingness to cooperate with other politicians.

 

 

  Our elected President appoints each individual governor. A full term is fourteen years (two seven-year terms). Unlike many other appointed positions, the governors cannot be dismissed once they are appointed to the Federal Reserve Board. Such job security was designed to insulate them from political pressures, but many argue that political pressures still remain.

 

  One of the seven terms expires every two years. A president serving eight years (two terms) will appoint four governors. Four governors out of seven would give that president a majority holding. If a governor resigns or dies, the replacement will serve only the remaining term. At the end of that term, a replacement would still be made. This keeps the order of the turnover consistent.

 

  It is likely that each president will appoint a governor that shares his views. The president hopes to have governors on the board that will accept his wishes. Of course, there have certainly been times when the FED has said “no” to both the President and Congress. Even so, knowing that their power comes from Congress, the Federal Reserve would prefer to say “yes” to requests when possible. Since inflation never happens immediately, the time period that it takes to show after printing excess money allows those actually responsible to deflect blame.

 

  How quickly does rising inflation become apparent? The stock market is usually affected by changes in money supplies within approximately one to three months. Employment downturns do not show until about one year after the new money enters the marketplace. The strongest effect on price inflation is not seen until 18 to 24 months following the emergence of the new money.

 

  The public tends to look at what immediately happened for the cause of inflation. This allows those responsible to deflect the real cause away from them. The public seldom realizes the true reason for an upturn in inflation happened as much as two years previously. Of course, even if the effects were immediate, it is unlikely that most people would realize the cause and effect. Who really knows when additional money has been printed and put into circulation?

 

  Not everyone agrees that printing money causes inflation. Some feel that tight money and high interest rates can also cause it. 

 

  No investment specifically deals with inflation. Gold sellers often advertise those precious metals, especially gold, is an inflation hedge, but that is not necessarily so. Investment combinations are the best hedges against inflation. This is good news for the professionals that work with investments. It means there is a need for multiple types of investment agents.

 

 

Permanent and Variable Portfolios

 

  Most professionals would agree that a successful investment strategy typically includes both a permanent and a variable portfolio. As the name implies, a permanent portfolio is intended to be permanent and long-term. Such investments are kept for many years and are expected to yield best over a length of time (at least five years and preferably no less than ten). Permanent portfolios are the type used for long-term goals, such as retirement. Long-term investments are not concerned with the ups and downs that would affect short-term investments.

 

 

  The variable portfolios are designed for short-term investments.  They are variable because they are flexible. Changes are expected as goals are reached, and new ones established. Short-term goals are the most likely to be affected by inflation and other variables since such investments do not have time on their side.

 

  The division of investment funds between long-term permanent investments and short-term variable ones will depend upon the person investing and their goals. Their risk tolerance will also be a factor.  Few people have large sums of money to work with initially. Most investors start small and save over a period of time. Therefore, it is likely that short-term variable portfolios will be developed before long-term permanent ones.

 

  As every agent knows, the hardest part is getting the individual to begin a savings plan of any type. It is much easier to spend than it is to save. In addition, if savings are not done prudently, inflation will eat up any earnings that develop. The sooner that one begins saving, however, the less they will need to save over time. Interest earnings and time are a saver’s best financial friends.

 

  Baby boomers are now entering retirement. Many received or will receive their pension nest eggs in lump sums as they leave work and enter retirement. The first and most important thing, says Craig Brimhall, vice president of wealth strategies for American Express Financial Advisors, is: “don’t spend it.” When a lump sum is received there is the tendency to spend at least part on items that would not otherwise be purchased (a motor home, boat, or fancy car are favorites). All the money received will be needed in retirement.

 

  The first baby boomers became 59½ in July of 2005. Many of the retirees rely heavily on 401(k) plans, individual retirement accounts, or other pension savings plans that are outside of the traditional pension plans their parents received through employment. While many baby boomers may have pensions, it may take more than that to make it through retirement. In 2001 58 percent of all households were dependent solely on defined contribution plans, such as 401(k) plans, where the amount received in retirement directly reflected what the individuals had done for themselves.[1]

 

 

  Retirees should not underestimate their life expectancy. For a couple retiring at age 65, at least one of them will statistically live to age 92.  The biggest danger to retiring is living longer than one’s assets can cover. To prevent this, a retiree should withdraw no more than 4 percent to 6 percent each year, which can be a tremendous challenge if insufficient funds have been saved. Retirees commonly overspend by $20,000 per year depleting funds that were intended to last for thirty years.

 

  Retirees should not give away any money or asset that may be needed for their support during retirement. It is a mistake to give a child or grandchild a big chunk of money too soon in retirement.

 

  There will be many expenses that may not immediately be considered. If the retiree or his or her spouse becomes ill, who will care for them?  If there is no child or grandchild available, then some type of insurance must be considered.  When we ask if someone will be available, we mean for sure. The old “don’t-worry-I-will-care-for-you” line can’t be taken at face value. Does the child work out of necessity? If so, it is unlikely he or she can quit their job to care for a parent. Does the child have the temperament to provide 24-hour care seven days per week? It is not an easy job. Professionals only put in eight hours per day, and they find the work exhausting. Imagine trying to care for an ill, frail parent around the clock – perhaps with no one to provide a break from the routine.

 

  Retirees must plan on paying for their care even if a child or grandchild has expressed their willingness to perform the service. A promise made today may not be performed five or ten years later when circumstances have changed. It is never wise to rely on specific individuals for another reason: the type of care required may be beyond the abilities of a family member to deliver. Some types of care require schooling or abilities that family members may not possess.

 

 

  It is always better to over-plan than under-plan. Too much money is always better than too little. Most people will wish, want, and pray themselves into retirement. They will have spent rather than saved; it seems to be the American way. As a result, we tether our children and grandchildren to mountains of debt paying for our care and the care of millions of others who also failed to adequately plan for their retirement.

 

  There is no logical excuse for failing to save adequately for our retirement. There may be reasons we lean on, but ultimately each of us is responsible for saving sufficiently. After all, it is not something we didn’t know would eventually arrive. Yes, it might mean taking on a part-time weekend job to find those extra retirement dollars to add to our 401(k) Plan at work. Yes, it might mean taking advantage of available overtime at work, earmarking the additional funds for our annuity account. Yes, it might mean we don’t buy a new car every three or four years. Yes, it might even mean our children will have to fund their own college education.

 

  The longer an individual puts off saving for retirement the more he or she must save. Time is a powerful ally.  It allows a person to save less and still end up with more. If a thirty-year-old began saving on a regular basis for their retirement, he or she will need to save far fewer dollars than the person who waits until age 45 to begin retirement saving.

 

 

  The ultimate goal is to have enough assets to last until the day we die. Since there is seldom any information available to tell us exactly how long we will live, we must plan for a long life. After all, it is always better to have saved too much money than too little. Americans commonly outlive their assets. As a result, we must rely on our children, and grandchildren (who should be putting their money aside for their own retirement) to help pay our bills. Eventually, many people will end up applying for government aid in one form or another.  This means tax dollars will support us, which (again) will be coming from our children and grandchildren.

 

  While inflation will lessen the buying ability of whatever we save, there must still be a starting point. How much money is currently required to live on per year? Whether that figure is $40,000 or $100,000 it is a starting point; never expect to need less. Most people have developed a lifestyle that they want to continue. In addition, while there may be some expenses that disappear in retirement, there will be others that develop (such as long-term care needs or general health insurance). When inflation is included, today’s living costs may be greater in retirement, not less.

 

  If a household is currently living on $100,000 per year, the individual or couple must multiply that by the number of years they expect to live without earned income. Many professionals consider thirty years to be a practical figure, but it may be wise to consider personal family history. A person retiring at age 60 will need more retirement money than would a person retiring at age 65. Like Social Security income, waiting to retire means more money for retirement. That additional five years of earned income will allow additional retirement savings and it will mean additional time for interest income. 

 

  It is always best to overestimate than under estimate the amount of money necessary for retirement. We do not know what our health status will be or what expenses may develop that we had not considered. We do not know if we will be able to live twenty years from now on the same amount of money that we currently live on. If we have a modest lifestyle, $30,000 per year may be adequate ($2,500 per month before taxes). Thirty years multiplied by $30,000 equals $900,000. Thirty years multiplied by $40,000 per year equals $1.2 million. Many experts feel that is a low figure since people are living longer than ever before and inflation will erode buying power.

 

 

 

  Our bills will also affect what we need for retirement income. If our home is paid for that will greatly affect how much is needed in retirement. There will still be maintenance costs, insurance, and property taxes, however. These costs must still be factored in. Home maintenance is especially likely since our home ages right along with us. Pipes and electrical systems may need to be updated for safety.  Our home may need to be modified if wheelchairs or walkers become necessary. A bathroom may need to be completely remodeled for developing disabilities. Our washer and dryer may need to be replaced.  These are the types of expenses that are often overlooked.

 

  Americans always believe that everything will work out. They believe their home will become their retirement income; they believe their Social Security will be adequate; they believe someone (perhaps the government) will provide their retirement funding. What many do not seem to believe is that they are responsible for their own retirement income. Even if they sell their home, they must live somewhere. Who will pay the rent? Social Security has never been adequate and never will be. In fact, as there are fewer taxpayers paying into the system, it is likely that Social Security will be forced to find new ways to cut payments. The government is always looking for ways to cut funding; no one can realistically expect them to begin paying more.

 

  Will assets last until death? This is a question that deserves serious consideration. It is not a question that should be considered on the eve of retirement. It must be considered prior to age forty and the earlier the better. Ideally, retirement planning should begin around age thirty, although statistically it is reported that most people only begin considering their retirement funding at age 45 (the age when children are usually out of the home and on their own). If retirement is not considered until age 45 there is only seventeen to twenty years available for accumulation and interest earnings. As a result, it is much more difficult to amass the approximately one million dollars that will be required for thirty years or more of retirement. Few people realize the amount of money that will be needed in retirement, looking instead towards company pension plans, Social Security income, and the proceeds from selling their homes. Increasingly fewer people can count on a company pension plan and unfortunately many workers who could utilize their company’s 401(k) plans are failing to do so.  Those who are predicting increasing numbers of poverty-stricken elderly are probably correct. If that does indeed happen, government funding of medical care and other retirement needs may be forced to increase affecting all who pay taxes. The most profoundly affected are likely to be poor children who will receive increasingly less help through government programs. At some point there will simply not be enough tax dollars to support other segments of the population as the retired and impoverished elderly eat up America’s resources.

 

 

End of Chapter 2