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The problem with safe investments

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My dad used to keep large amounts in his checking account (no interest) and a passbook savings account (4%, if I remember). Whenever I wanted to talk about investments, he’d tell me to “go blow”, and how happy he was that his money was safe and he wasn’t losing anything.

Then he got into the hands of a charming broker, who (he pointed out) called him more often than I did. The broker recommended tons of what Dad thought were “safe” investments—can’t miss stocks and bonds, which Dad was sure were safe. Unfortunately, the stocks missed, the bonds were junk, and when I wrested control of it all in 2007, I calculated the charmer had lost him about $300,000 in junk investments and commissions from churning the account.

Dad was completely wrong in both instances.

The second is easily addressed—don’t invest in anything where you don’t understand the rationale. If someone is recommending something, understand why you should invest. And if someone is your investment advisor, at least understand what their recommendations are based on, and whether they have a plan for your entire portfolio, not just a bunch of “hot” investments. Invest in individual stocks if you want, but be okay with losing Every. Last. Cent. (I’ve had a few of those.)

If only I had a buck for everyone who told me how nice their broker was! Do you think they’d ever sell anything if they had horns and a forked tail?

But let’s look at Dad’s first principle—cash is safe. Is it?

Mom and Dad were flying high in the early 80s, when they were buying and rolling over CDs that were paying somewhere around 15%. They were living off the interest and living well—nobody had ever explained to them “safe withdrawal rates” and they spent all the interest, because after all, their principle was safe. It was only when rates began to crater that they fell into the clutches and promises of Todd, looking to replace that great, but now unobtainable return. So here was the first problem (ok boring name): reinvestment risk. We’re seeing the same thing today with CDs, which have hovered over 5% for some months now—it seems like a fortune compared to what they’ve been paying for years. But most of these high flyers are only for 6 months or 1 year. Bankers aren’t that stupid, and they don’t want to be locked into paying higher rates if and when interest rates drop. The longer the current CD term, the lower the rate.

Mom and Dad couldn’t find anything that paid 15% by the 90s. Since they’d spent all the interest, and inflation had definitely gone up in the meantime, their principal couldn’t pay for as much as it once might have.

This is why cash isn’t as safe as they (and maybe you?) believe. It’s called lost opportunity cost.

I’m going to work through some figures here to see what those CDs actually cost them. Bear with me. Let’s work with $10,000, available and invested on March 31, 1980 and kept invested until 1990 reinvesting the original $10,000 and putting whatever they made in their mattress. That’s not what they did, but let’s compare. Based on what I was able to find, they would have made 98.94% on their money, or $9,984=$19,984. This is figuring only simple interest for each year, and does not reflect the value of compounding—i.e. leaving the money invested, or reinvesting the total principle + earnings each year.

However, let’s say they’d picked a relatively benign fund, like the Vanguard Wellington, which was around back then. In simple interest terms, they would have earned 164.54% on their money, or had $26,454 in simple return ($36,454 total). No compounding—and this return would be a combination of yield and share price improvement. NB if we were to include compound returns (which I wasn’t able to calculate for the CD), the Wellington would have had a total return of 372.21%, or their $10,000 would have grown to $47,220.57 (Source: Morningstar & Forbes).  Their opting for “safety” actually cost them at least $16,470. That is LOST OPPORTUNITY. *

It’s true that Wellington actually lost money in two of those years (1981-82, -1.32% and 1987-88, down 0.94%), but in every other year it exceeded returns of CDs, sometimes by 20 points or more.  Granted, these were go-go years, but that was true for both investments.

The take away? If you absolutely must have your money, with no loss whatsoever, in a very short period, you probably need to suffer with cash. Having cash can tide you through some bad market years if you must meet expenses during those years from a portfolio. But if you can afford to park your money for a longer period (say, 5 years or more), you are paying an awful lot for supposed safety—the lost opportunity of far better investment returns.

*Please forgive me that these figures are somewhat imprecise depending on what date I picked and the difference between simple and compounded. But I’m certain the general principle holds.

When should you retire?

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I hear all versions of opinions on retiring—it ranges from “as early as possible” to “never”. While this is primarily directed to people who can afford to consider it, that is definitely not the case with everyone. So first, some factors in deciding whether you can afford it at all:

  1. Do you have enough guaranteed income to cover (at least) your fixed expenses? If you have good Social Security and a pension (that endangered species), you probably can afford it, especially if there’s a cost-of-living increase as part of your pension. You lucky duck.
  2. Do you have an investment portfolio sufficiently large to make up any shortfall? You can take a quick look and see if a 4% (or, stretching it, 5%) withdrawal will cover the rest of what you need. But also think carefully about what changes you may need to make. What if the market dropped by 1/3? Could you tighten your belt enough or put off discretionary expenses to cope with a lower withdrawal?
  3. Could you work part-time, as a consultant, or start a business with low start-up costs? This can work well for healthy, youngish retireds, but it’s not really feasible for older retireds who may begin to experience health issues. If the extra income is gravy, great, but if it’s essential any illness is going to be catastrophic.

 

Okay, you can afford it. Now, should you?

  1. How old are you? The younger you are, the longer your money will have to last, and the more certain it is that you’ll experience more market crashes. You’ll need either more money or a slower withdrawal rate.
  2. What will you do about medical insurance? If your employer has paid at least some of your insurance, you might be shocked at the actual cost of individual insurance (previously self-employed, not so much). Currently, you can’t get Medicare until 65, so check out insurance costs before you announce retirement. Even once you’re on Medicare, you’ll still have to pay for insurance for prescriptions and supplementary, and long term care insurance if you won’t be able to cover around $100,000 a year (in today’s dollars).
  3. Are you irreplaceable? The answer to that is probably no, no matter what you think. Sure, you may be the best producer, the best manager, the most skilled…but if a truck ran you over, they’d find somebody else. Exceptions may be medical personnel in rural areas and small towns, some politicians and leaders, and anyone who provides a unique or hard to obtain service, skill, or product, especially solo. Ok, I’ll concede that you might be the best at what you do, but the world will go on. Check your ego!
  4. Do you know what you’ll do with yourself? If your whole life or your identity has always been your job, you need some soul searching. Everyone needs a meaning in life, but at any age you can find new meaning, or hobbies, or learn something you never had time for, or friends…it’s very sad when someone retires and can’t stand it. It’s a failure of imagination and dimension, and a sure sign you need to grow your soul.
  5. Do you have any social outlets? Many people miss the social group built in to some workplaces. Truth is, all your friends are getting older, too, and even if you stay past your expiration date, they’ll probably be moving on. Find some interest group you can be part of, even if online.
  6. Is it time to give somebody else a chance? If your employees and coworker have any idea you’re working past retirement, they are almost certainly muttering about you—when is she ever going to leave? Doesn’t he have anything better to do? And they’ve almost certainly considered that they won’t move up while you’re still blocking the ladder. The best will leave for better opportunities. Don’t think upper management hasn’t thought of this. Not only do they not want to lose the best, they’ve also probably calculated that they could hire someone cheaper than you. You’re only one knee replacement away from them figuring out a way to ease you out. Maybe it’s time to go out on your own volition, in dignity and glory. If you’re all that indispensable, they’ll call you back as a consultant, but don’t bank on it.
  7. Just how old are you? Many people are healthy and sharp in their 70s. Some are, in their 80s. Some are Warren Buffett. But after 80, continuing to work really requires a Plan B: fewer days, fewer hours, fewer clients, more support for mundane tasks. Really, don’t you have anything else to do?
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Dollar cost averaging: what is it and should you do it?

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Dollar cost averaging is contributing money to an investment over time, rather than plunking in a big chunk at one time. You might designate a specific amount to be invested each month (or week, or quarter). Conversely, you might put in your whole amount at the beginning or end of year, or whenever you get that bonus or pension payout or inheritance. Which is better?

I was recently reading an investment article by a well-known academic. He used his model 12 asset portfolio and explored the option of investing $100 every month in that portfolio, for 25 years. The ending account value was $68,580 (your investment was $30,000 total). That didn’t look so hot to me, so I used an online investing calculator which gave an annualized return of 6.062%. He’s weighting each of the assets equally and rebalancing once a month (!!!)   That gives him approximately a 65/35% balance in favor of equities. He is using 12 indexes, which as we all know are not directly investable—mutual funds will likely have a slightly lower performance because of management fees. And, without at least knowing the Standard Deviation, it’s hard to see how much risk an investor would be taking. ~6% is pretty standard a performance.

But there is one advantage of investing monthly—potentially it allows you to buy at a lower average cost per share. If you buy on any given day, you have only one chance in 252 market trading days of hitting either the highest or lowest day. If you invest monthly, you have 12 chances, but it’s still unlikely that you’ll hit the lowest or highest trading day, unless you are very, very unlucky—you’ve diversified your risk. Still, since the market is up more than it’s down, your share cost will increase over time (which is what you’re hoping for, in a way, if you want to make any money). Also, if you’re investing a specific amount of money, you’ll buy more shares when the investment is cheaper, and less when it’s expensive. Finally, setting up monthly investments has the advantage that you might actually DO it. Dithering usually results in skipping at times—and there is never a good time.

But what about if you get a lump sum? By reserving some portion, you’re losing all the dividends and capital gains payments made, if reinvested. Let’s say that instead of investing $100/month over 25 years, you had invested that $30,000 all at once in his asset portfolio, held it for 25 years, and earned 6.062% annually. If I’m pressing the buttons on my calculator correctly, you’d have $130,652.15, over 45% more—so dollar cost averaging a lump sum over time could cost you a lot. But managing $100 a month contribution into 12 assets over 25 years is a pretty daunting prospect—if you can even find funds that would allow you to contribute $8.33 a month to each fund. So, let’s look at something easier. What if you had put that $30,000 “inheritance” into just one balanced fund, say Vanguard Wellington (no investment recommendation intended).  $30,000 invested on December 31, 1997 would have grown to $184,743.75 by December 31st, 2022, according to Morningstar. (I’m using the article’s measurement dates—Dec. 31, 2022 wasn’t a trading day.) I wish I could show you dollar cost averaging into VWELX, but it’s beyond my powers to calculate and the data obtainable—they only show 15 years, where the annualized return is 7.45%.

Those who are more skilled at statistics than I am may find these figures arguable (isn’t almost everything, depending on how you set it up?), so I refer you to this article. Investing regularly has the advantage that you might actually do it. But, while investing a large lump sum may require a big gulp and a leap of faith in the future (and some scary days of bad markets), you’re probably going to be better off than holding back anything in cash.