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MAKING CENTS OUT OF THE NEWS
Blog #27
(July 16th, 2009)
GETTING THROUGH RETIREMENT WITH GRACE, HEALTH – AND CASH
By Tom McAllister, CFP®
The biggest risk facing retirees is the very risk they most often ignore. The good news: a man in good health at 65 can expect to live twenty years more on average; a woman can expect to live nearly twenty-five years following age 65. Three quarters of the time, wives survive their husbands by eight to ten years. The bad news: inflation’s negative impact is dramatically enhanced by increased longevity.
Exactly how dangerous is inflation’s effect on retirement security? In its more than two hundred years of existence, the United States of America has experienced an average annual monetary inflation factor of 3%. For the last thirty nine of those years, the rate has been closer to 4% inflation a year. Still, folks continue to blithely plan their retirement based on a fixed income, assuming their $4,000 or $5,000 each month will be sufficient to maintain their standard of living for the rest of their lives.
I often use postage stamp prices as an analogy. Thirty five years ago, a first class stamp cost 13 cents. Today that same stamp is 44 cents. What will it cost in 2034?
Unless one’s retirement income is “indexed” for inflation (meaning it will rise to make up for inflation the way Social Security benefits do), it is very dangerous to rely on a fixed income portfolio for one’s retirement needs. Few private pensions are indexed, by the way; most government pensions are. This fact may explain why Congress, with its own quite generous, indexed, pension plan, tends to ignore inflation. (Indeed, Congress appears to encourage inflation, since inflation makes government debt cheaper to repay.)
For retirees to protect themselves against the almost certain devaluation of their fixed income pensions and fixed income investments, they must make investments that will grow rather than shrink. The most popular avenues to achieving such a result are the ownership of businesses, real estate, and stock.
The majority of U.S. citizens own their own homes. Home ownership is an investment of sorts, especially if the home is completely paid for, as is the ideal scenario in retirement. The return on that home investment is having no rent to pay, plus the appreciation of the real estate over time, keeping pace with inflation. The growing equity in a home can provide a source of savings towards the very real possibility of nursing home care late in life.
Of course, there is also the possibility of investing in real estate other than one’s primary residence. Many retirees own rentals, either residential or commercial. Often owners perform a great deal of labor, handling rental details and basic maintenance themselves, rather than hiring professionals at greater cost. As retirees grow older, the associated chores become more onerous, and inevitably the cost of hiring others rises. Nevertheless, rental real estate can serve as an excellent investment vehicle for combating inflation. In fact, the use of mortgages can render inflation a plus for the investor.
The simplest way of coping with inflation remains investment in the stock market. There are few, if any, time-consuming maintenance duties. Contrary to some opinion, stock investments are not always speculative. True, in the past year we experienced a systemic failure of the c credit markets and severe recession; yet over the longer term (ten years or more), stocks have easily outpaced bonds, certificates of deposit, and other fixed income vehicles, even outpacing real estate purchased for cash (with no mortgage). The average annual return on stocks since 1920 has been in excess of 9%, as compared with 5-7% gains on real estate.
In forty-seven years of advising investors, I have seen only two periods of time, 1975 and 2002, in which stock “bargains” were available that were by any measure comparable to those ripe for the picking in 2009. This spring, the stock market rallied more than 25% from its lows. Still, the market is historically undervalued. In the most recent months, the market has done what is called “climb a wall of worry”. The worries are about the new administration and the national and world economies. “Climbing” means that, despite these worries, the market has recently shown unusual strength, especially given the continually deteriorating economic picture. Such strength has, in the past, proven to be a precursor of gains in the coming one to five years.
Uncertain times such as we’re experiencing today - these are the very times investors the likes of John Templeton and Warren Buffett consider to be the best in terms of opportunity. As Templeton put it so aptly, “These are the times stocks return to their rightful owners.” For those with available funds and a reasonably longer-term outlook, the coming weeks and months present an excellent chance to purchase quality stocks at reasonable prices. (Stocks paying better than average dividends represent an especially good buy, especially since, even under the current administration's plan, dividends will be federally taxable at no more than 20%.)
Managing retirement finances with grace and cash means staying aware of the risks presented by inflation, while taking advantage of the unusual profit opportunities presented by the investment markets.
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