Where Can I Find Safe Income For Retirement?
Summary What should a retiree do? Where should he go? How can one get income with safety? The Question You don’t want to rely on ever seeing another paycheck. You want a steady income. But you demand safety – the lowest possible chance of a permanent impairment of capital. So you won’t simply overpay in order to construct the appearance of steady income. So, what are you supposed to do? Non-Answers and Bad Answers The easiest way to address the question is to ignore it, then offer a non-answer by violating at least one critical element. You could take a flier on something and then double down when it crashes… but that is problematic if you are not expecting subsequent paychecks with which to double down. You could forego a steady income, draw down savings, and live above or below your means… but above sounds dangerous and below sounds miserable. You could invest heavily in investment grade and government bonds for a steady paycheck… but that does not take into account the risk of overpaying. These are all non-answers. High priced helpers/”HPHs” are typically enthusiastic in their view that this is all so complex that you should spend a lot of money on fees for high priced helpers. Annuity salesmen are second to none in their single-minded view that you should buy an annuity. Private bankers are no better (but mine has good coffee and real paintings instead of burnt coffee and motivational posters). You hear folksy advice such as, “own bonds in a percentage equal to your age” or “focus exclusively on dividends and high-quality companies.” This is real advice, but it is also bad advice. Part of the problem that allows charlatans to get away with flimflam is that older folks are often easy prey. They are often honest and expect others to be too. They are often used to their lives before retirement, so are a bit disoriented by changes as they move into retirement. Many want a reassuring, friendly advisor. These obvious and perfectly reasonable market demands are supplied by many people with firm handshakes, steady eye contact, reassuringly modulated vocal tones, and utterly vacuous ideas about investing. The Standard Before trying to offer a sensible answer, I want to raise the standard for what a valuable answer would look like. It takes seriously the charge that you have seen your last paycheck. You know that it is increasingly common to see 80-year old Wal-Mart (NYSE: WMT ) greeters and you do not intend to ever be one. That means that your investments need to sustain you and your spouse for your remaining years. Oh, and thanks to modern medicine, that life expectancy could be much longer and much more expensive than anything you ever imagined. Your steady income should come from investments that meet the same standard that should be maintained by anyone else: they should be available for purchase at a significant discount to their intrinsic values. Never overpay. You certainly should not start now. Cost Savings and Tax Efficiency I am not a big fan of self-sacrifice. At least I prefer getting onto the efficiency curve before doing anything sacrificial. To that end, a key step in retirement planning is to zero out all of the expenses for goods and services that you don’t care about. This is a great time to kill off any habits. You might have paid a given bill for five years or for fifty years, but if it is not for something that you need or love, then cancel it. One of the biggest cost centers can be your home. Are you paying for a lot of externalities (if you live in Manhattan, the answer is “yes”)? Do you love your nightly table at Masa and front row seats at Broadway openings? If not, then move. I do not intend this to be overly prescriptive. Instead, my goal is to advocate for intentionality. But there are some great choices beyond heaven’s Floridian waiting room. Domestically, Wyoming is a favorite of mine. Internationally, Dominica is worth checking out. But any expenses should be reflective of only what you need or what you love. Just because you come from Detroit, doesn’t mean that you have to stay (even if there are some real estate bargains ). While everybody has unique preferences, I cannot imagine a good reason to pay any state income tax in retirement. My wife vetoed Alaskan winters, but other than that, there are some great income-tax-free states. In terms of weather and other seasonal hardships associated with income-tax-free states, that can be avoided, too, if you are willing to couple undesirable seasons at home with off-season travel abroad. I, for example, dislike turkey so have gone to Paris for several Thanksgivings at dirt cheap prices. No Bonds HPHs frequently think of risk as a function of asset class along the lines of “cash is safe, stock is risky, and bonds are in the middle”. In reality, risk is never a function of asset class; it is a function of price. Thinking proxies such as asset class-based risk models are designed only to excuse HPHs from doing any fundamental analysis to determine value. They can’t make you safe because they can’t even define, let alone quantify, risk. If you are a 65-year-old retiree, a smart sounding HPHs might say that you should be 65% in bonds, with others arguing importantly that the right number is 70% or 60%. The right number is 0%. Alternatively, come up with an explanation of how the credit market is currently undervalued. I could, of course, be completely wrong, but the current credit market looks like an epic bubble. It is conventional to own a lot of bonds, but when the bubble bursts, you will conventionally lose a lot of money. Bond Substitutes The equity market offers compelling bond substitutes that offer yields in excess of investment grade bonds with less risk in the form of event-driven opportunities. Here are the prospective opportunities in current deal spreads. A portfolio of these, whether in a fund or on their own, is both safer and more lucrative than bonds. Returns are listed on an annualized basis. Click on comments for additional deals on the specific opportunities. The best seven risk-adjusted opportunities are in bold. Either a concentration on the seven that I identified as the best risk-adjusted returns or portfolio of the broader list could help diversify and add yield to a portfolio while lowering its sensitivity to the overall market direction. Cash Cash is an investment in your future flexibility. I keep a cash balance of at least 20% of my assets. In addition to its convenience and its stability, I recently mentioned that: Cash has other virtues. Instead of buying real estate with cash, my local mortgage broker got me a tax-efficient mortgage that costs 2% before taxes (and less on an after tax net basis). This allows me to build up a larger pile of cash on the sidelines to use opportunistically. I have hundreds of separate deposit accounts, most with balances beneath the $250,000 deposit insurance cap. I keep these accounts in institutions with diverse geographies and regulatory jurisdictions. Most are at institutions that have equity options attached to their deposits in the form of potential future mutual conversions. So even if your cash allocation is on the high side, it does not dilute your overall performance, as long as you can exploit a half-dozen to dozen conversions each decade. Equity For some significant part of your equity exposure, you will beat most peers by simple, low-cost, tax-efficient passive exposure. While I would not quibble over details, Vanguard’s Total Stock Market Portfolio is my personal favorite. You get a bunch of free trades with balances over $10 million, too (and some with balances over $1 million). I have a mild preference for the mutual structure (I appreciate the irony given that a large part of my investment history has been exploiting de-mutualizations). Real Estate Inflation is a retirement killer. My #1 favorite inflation hedge is to simply pre-purchase the stuff you want in retirement. As I recently wrote : This doesn’t work with technology or lettuce, but if you have a good sense of what you want when you retire, just go ahead and buy it. Pre-purchasing the stuff you are going to want is the world’s most perfect inflation hedge. This works best if you have pretty durable tastes. For instance, if (as is my case) you are land-crazy and want to live on the water… just buy up waterfront land. If it is just what I want to own, it matters little to me if it goes down 99% or up 99% in terms of nominal dollar value. Either way, it is still worth 1x the land that I want to own and am not going to sell. It is an end in itself. So, if you know where you want to end up, lock in the real estate at today’s prices. Conclusion If this sounds much like what anyone else should do, that is because it is. Your investments are not about you. They are about upsides, downsides, and probabilities. Anything else is just patronizing HPHs putting your money at risk and jeopardizing your retirement. But if you think for yourself and focus on safety, the decades ahead could look like one long Cialis commercial. Disclosure: I am/we are long DEPO, PRGO, ALTR, WMB, ISSI, PNK, BHI. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital. Rangeley invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our investors, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.