Wouldn’t it be nice . . .?

Forty years ago, we were singing along with the Beach Boys, “Wouldn’t it be nice if we were older?” As the difficulty of these very basic retirement questions indicates, “being older” brings some challenges, too. But, every retiree – current or soon-to-be – needs to answer these questions. Here are my answers:

How much do I need in liquid reserves in retirement? I feel I need at least six months of subsistence spending readily available in share draft accounts, savings accounts, and very short-term, fixed income investments. I’d also like to have another six months or more in semi-liquid assets – intermediate-term, high quality bond funds, term CDs, etc. The rest of my retirement nest egg can be in a diversified portfolio of long-term investments. (I’ll also do some things to help assure that this level of reserves is enough. We can talk about that later.)

How do I know when stock or bond prices are “depressed” (and I should wait for a recovery before selling)? For me, this question has a two-part answer. First, I hope to never have to make this decision. Ideally, I will be able to gradually liquidate our long-term investments in hundreds of small increments through a life-long systematic withdrawal/liquidation program. This will steadily “drip” dollars into my liquid reserves, from which we will pay our living costs. This gradual liquidation program will make timing virtually a non-issue. It will capture essentially the asset allocation’s balance-weighted average return over the life of the portfolio.

But, no mater how hard I try, I suspect that occasionally the drips won’t keep up and I will have to come up with what constitutes a veritable bucket of cash – for another year of college for one or more of my progeny, a once-in-a-lifetime trip with my soul mate, whatever. Hopefully, I’ll be able to fund these out of my second-tier reserves, and then take some time replenishing them with a period of doubling up the systematic drips. But, when that isn’t enough, here’s what I plan to do.

1. I will consider selling some of whichever asset class has done the best over the last few years relative to its long-term average return. Currently, that might include funds focused on mid-cap value stocks or the lowest quality junk bonds.

2. If I am feeling particularly depressed about the investment markets – if the economic environment is tenuous and most market prognosticators are bearish – I will do everything I can to not sell anything, particularly not anything that has declined to valuation levels that are well below their historical average. Instead, I will consider borrowing from my friendly credit union. Or, maybe just deferring the expenditure, thereby deferring the need to liquidate long-term investments.

So, as this indicates, the factor I will use to indicate when the investment markets are depressed . . . is my own current state of “economic depression.” If I and most of my fellow investors are afraid of the markets, chances are the markets are beaten down by the selling of more skittish investors. Likewise, if everything looks rosy, the more speculative investors have probably been throwing money into the market, making it a good time to raise some extra cash.

Tough to do? Definitely! The first alternative – gradually liquidating investments over a number of years – is unquestionably the easier and safer approach for any normally emotional human being. But, if you find yourself in need of extra cash and are able to act exactly contrary to your current state of mind, you are likely to do better than if you just go with the feeling of the moment.

That might have worked in the 60s and 70s. We were young and stupid then. But, this is now. We’re just (emotionally) stupid . . . and running out of time.

And, we have a winner!

If you haven’t done so yet, click on “comments” below. You’ll see the four responses that (1) the authors allowed me to post, (2) had enough substance to warrant posting, and (3) were appropriate for this family-friendly site.

Instead of doing the drawing for two winners, we have decided to take the public schools approach and award a prize to each of the four. Michael Armour wins for the shortest right answer, Tim Hamele for the most conservative right answer, Richard Corbin for the most real right answer, and jddeadendfarm for the most entertaining right answer.

So, we need each of you winners to email (or “comment” again) your shirt size to us and we’ll send one of the very attractive and high quality (really!) MEMBERS Capital Advisors polo shirts to each of you. If you have a color preference, cross your fingers and you might get lucky.

Thanks to each of you four for participating, and to all the others for . . . all the fun ideas that you shared!

I’ll give you my thoughts on these questions later in the week.

Hey! Free Stuff!!

No ideas? Come on, folks. There’s a free MEMBERS Capital Advisors shirt/blouse for each of two lucky contributors. Send in your answer to one or both questions. We’ll put all your names (or email addresses) in a hat and draw one for each question:

How much do you need in liquid reserves in retirement?

How do you know when stock or bond prices are “depressed” (and you should wait for a recovery before selling)?

So, send me your thoughts on this. If you don’t want them posted or attributed to you, just say so.

Enjoy this special weekend!

Protecting Your Nest Egg

We’ve been talking about why investment risk matters most right at retirement. First, that’s typically when you have the most invested and, therefore, the most to lose. And, that’s when your ability to recover from a financial setback becomes increasingly limited due to the shortening length of time before you need the money, and your gradual consumption of your financial assets, leaving less and less to provide future growth and income.

How do you manage this risk? Diversification is the usual answer, and this definitely is important for the longer-term portion of your investment portfolio. But, at times like we saw earlier this month, nearly all asset classes can plummet in price at the same time in response to a market shock.

So, the only sure way to avoid suffering losses at the wrong time is . . . by not taking price risk with the money you will need to live on as you await the market recovery.

Are those “duhs” I’m hearing?

We all wish there were an easier answer, but the only sure way to eliminate this risk is with the classic rainy day fund – a cushion of liquid reserves invested in price-stable investments. These include share savings accounts, time deposits, money market mutual funds, and short-term bonds. (They could also include stocks and long-term bonds protected by some kind of options or futures hedge, but this effectively turns them into short-term, lower return assets and is a complex undertaking not suitable for most investors.)

The goal is to have cash reserves sufficient to never have to sell long-term investments when they are at depressed prices. This, of course, raises two more questions: How much do you need in liquid reserves? And, how do you know when prices are “depressed?” Tough questions. Any suggestions?

Subprime Outlook

One more comment on the subprime mortgage issue. I believe it will have a broader and more negative impact on the economy than is currently reflected in the stock and bond markets. Federal Reserve efforts to soothe the wounded with lower interest rates won’t help because, thanks to tighter real estate lending policies (from the lenders and their regulators) and the growing risk of further defaults, the problem will be the availability of credit, not the price of credit -- it will be cheap to borrow, but only strong borrowers will qualify.

Will this be bad for investors? For those who have to sell assets at depressed prices, yes. But, this kind of risk can be minimized. I’ll share some thoughts on that later in the week.

With Age Comes Wisdumb?

Interesting article in The Wall Street Journal yesterday. Under the title, “Why Middle Age May Be Healthy for Your Wallet,” it describes the findings of a study to determine the age at which people make the fewest financial mistakes. It defines mistakes as things like not getting the lowest available interest rate on a loan or getting stuck with readily avoidable credit card fees.

The optimum age, it turns out, is just over 53. People younger or older make more mistakes than do 53-year-olds, and the mistakes increase as you move away from 53 in either direction.

The researchers attribute this to the crossover between declining mental abilities (which begins at about age 20) and accumulating experience (which begins as soon as we start paying attention – sometimes well after 20). They also acknowledge, though, that some of this may be attributable simply to the different eras in which each generation grew up.

Both explanations sound reasonable. But, I think there is also another one. As we move through middle age, our focus on maximizing our wealth peaks. Prior to that, we’re distracted by thoughts of building relationships, a family, a home, a self-image, a career, and all the other aspects of life and legacy. After that, most of us start to mellow out, realizing that it’s often more important to deal with the best people than to get the best deal. And, we’re more willing to sacrifice the attainment of “optimum” for simplicity.

Some may view this as getting soft, or even soft in the head. And, our brains may, indeed, be shriveling in size and assuming the texture and conductivity of Swiss cheese. At the same time, the pace at which we are experiencing new things (thereby enhancing our judgment) may be slowing as we settle more and more into our preferred routines (aka ruts). But, we are also usually becoming less internally focused. And less demanding of ourselves and of those around us.

You might even say that, as we become less financially rigorous, we become better people. Or, maybe it’s the other way around.

Either way, for most of us it’s probably a good trade.

Timing of Retirement Investing Losses

Continuing with the saga of the timing of retirement investing losses . . .

The first question posed earlier related to the timing of losses to any one lump sum investment over its lifetime. There, timing didn’t make any difference. But, timing does matter to a pool of such individual investments that grows over time with new investment dollars, and then shrinks as the money is withdrawn and spent. There, you want to have your losses early. You don’t want them right when you retire. Timing of losses does affect the value of your nest egg in this scenario.

The reason is much more logical than the answer to question one. It is easily envisioned by considering the first few days of building your anticipated pool of retirement investments – when it might have consisted of a small initial investment into a mutual fund. Any loss that happened to it then could change its terminal value a lot, but it wouldn’t affect the values of subsequent lump sum investments. A loss 40 years from now, however, will whack every investment you ever made into this pool, at least all that are still in there.

Most of us gradually build up our retirement investment assets over our working years. The total reaches its largest amount virtually at retirement, and then we draw it down gradually over our years in retirement. So, the most important time to avoid significant losses is right at retirement. From then on, of course, avoiding losses remains important for the reasons cited earlier – limited if any earned income coming in, and the difficulty of reducing your standard of living at that stage of life.

Patently obvious to the most casual observer, you say? Maybe so. Question one was the tricky one, not question two. But, we all know of people devastated by a market downturn right when they were retiring, or planning to retire, but then couldn’t. And, not just former Enron employees.

So, how do you keep your investment risk down while still going after good returns? Some thought on that next time.