Part 3 of a 3 part series on weathering the current financial storm …
By now you know that when we have made our Number, our #1 objective is to hold on to our money!
We do that by a combination of wise spending and savings habits (learned way back in Making Money 101, and practiced almost to the point of stupidity in Making Money 201) and very sound investing strategies.
Firstly, though, what do you do if you have just had the wind kicked out of your 401k’s sails by the sudden crash?
Well, it really shouldn’t be an issue, because the chances are that you planned for an annual stock market return of something like 11% – 12% over 20 years and you overachieved dramatically for most of it … but, rather than increasing your spending based upon your unexpected ‘good fortune’ you realized that all good things must come to an end and you gritted your teeth expecting a reversal to bring you back to earth.
In fact, if you were really smart, you set yourself 10 or 20 year ‘targets’ and when you achieved those, you started preparing for Making Money 301 early and sold down your excess stocks and/or real-estate (i.e. the equity in excess of your ‘target’) and moved it into cash, bonds, or far more boring commercial real-estate investments (using minimal, if any, borrowings).
Now you are retired (well, you at least aren’t counting on any outside income), but you have been battered and bruised a little by the current ‘meltdown’ so your buffer isn’t as large as it was a few months ago, but you are still OK.
[AJC: I’m speaking from personal experience, now]
Remember, your Rule of 20 strategy was designed to deliver 5% of your ‘nest egg’ to live off each year, leaving another 5% to be reinvested to keep pace with an expected 5% average inflation … in other words, produce an indefinite stream of annual income that grows with inflation.
The problem is 5% + 5% = 10% AFTER TAX, so we NEED a 12% to 15% compounded annual growth rate to make all of this work …
… and, the current crash has probably temporarily wiped out most of any buffer that we had managed to retire with i.e. any money that you managed to salt away in excess of expectations … who said that EXACTLY Your Number was going to fall into your lap EXACTLY on Your date?!
What to do, given that there are signs of a prolonged flattening of the market?
Here are a some advanced strategies, sensible in ANY market for Making Money 301, but particularly now:
1. Do NOT keep your money in CASH (other than a 2 year Emergency Fund) – if you have no buffer, then every year you earn ONLY 5% on your CD’s is a year that you are really LOSING 5% of the remaining value of your ‘nest egg’ to inflation!
Equally, do not keep it in a cash-equivalent (e.g. bonds – with the exception noted below) OR in stocks or Index Funds: you need a min. 5% return – indexed for inflation) UNLESS there are stocks that you understand/love that pay a 5% dividend and you are 100% certain that dividends won’t be cut in the coming recession.
2. Purchase commercial property for 100% cash or very low LVR (Loan-to-Valuation ratios), such that the net rents each year provide EXACTLY the annual income $$$ amount that you are looking for + 25% ‘buffer’ (for vacancies, repairs/maintenance/etc.). If you are worried by commercial, residential (or a mixture) is OK.
You can spend the entire rent (except for the buffer) as it will:
a. Keep up with inflation, because you will have a CPI ‘ratchet clause’ in your lease, if you rent well, and
b. Your capital (represented by the property itself) will also at least increase with inflation, if you buy well.
3. Buy a select group of ‘blue chip’ stocks that you love/understand (etc., etc.) on low historic P/E’s and write Covered Calls against them; this works well in a flat-to-slightly-growing market, so the current volatility may need to settle into a more extended period of gloom-with-some-slight-hope before you can execute properly … but, now’s a great time to start (very!) small and experiment!
4. Be boring: buy TIPS (Inflation protected Treasury Bonds), but only if you applied the Rule of 40 instead of the Rule of 20 … these currently only produce about 2.5% TAXABLE annual income (except if your Number is so small that ROTH IRA’s – or similar – will do the job for you).
Only buy the TIPS using 95% of your ‘nest egg’; retain 5% of your cash (over-and-above that emergency fund – although, holding TIPS means that you can probably cut this back, as well) … use it to start buying Calls against the market (pick an ETF that tracks the S&P 500) or, against 4 or 5 individual stocks if you are more daring.
While you’re waiting for the market to stabilize a little, now’s a good time to start slow and practice: after each major pull back, buy a Call and see if you can make a gain on the upswing (set a profit target and sell when your reach it … wait for the next ‘pull back’ and try again).
5. Buy a Fixed Annuity – costs suck, but if you can’t do 2. or 3., what’s really left for you besides TIPS or this?
And, if it (in fact, any of these strategies) produces your required Annual Income Number (the annuity MUST be indexed for inflation) who cares? But, remember to spread your risks over a few insurers (remember AIG?) … you don’t want them to go down holding your cash (keep in mind that even if the insurer crashes, your underlying investments should still be safe and be handed back to you … at least, that’s how the story goes)!
So, for any rich readers out there sweating my posts (you know, like the doctors who watch ER just to point out all the faults: “Oh, what a bunch of BS … he’d never spline the clavicle with a Humphreys 458!”):
What’s worked for you in past ‘bear markets’? What do you think will work for you in this one?
I recently had some friends stay with me from South Africa. They told me the interest rates over there are around 13%, the cost of living is very cheap if your coming over with Dollars instead of Rand and it’s beautiful. If I were moving onto MM 301 soon, I might consider it.
@ Josh – There’s a reason why the tidal wave of emigration is moving FROM ‘seth efrikka’ TO the USA 😉
most REIT’s, being real estate investment trusts, track real estate portfolios and not the S&P 500
@ Erick – Slip of the ‘pen’; should read ETF. Thanks for the quick pickup!
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