Note: I had another appearance on ABC 7. If you want to check it out click here https://www.mysuncoast.com/video/2020/02/06/abc-news-roundtable-discussion-february/
(my part starts at 5:00)
The Real Cost of a Free Steak Dinner
Judy retires from her middle management job at a box factory at age 65. While she adored the box industry, it was time for her to move on. She had diligently saved money into her 401k throughout her life, and found herself with a reasonable balance of $500,000.
During her box building career, she didn’t pay all that much attention to the plan. She began saving 10% of her income from the start, and quickly forgot about the deductions from her paycheck. She adjusted her lifestyle, and discovered pretty quickly that her 401k contribution didn’t cramp her style too much.
She had first met with human resources who told her to place her 401k into a diversified portfolio of funds available within the plan. Judy complied and continued on to her day to day work life. During her career, she would glance at her statement once or twice a year. She noticed that sometimes it went up and sometimes it went down, but overall it seemed like she was making money.
Then retirement came. And panic set in. What if her account drops? What if she runs out of money? Maybe the money needs to be somewhere else. Should I put it into something safer? I would like to make some money, but most importantly I don’t want to LOSE any money.
I hear this story every week, and the consequences of this way of thinking can be severe.
Judy receives an invitation in the mail to go to a retirement money seminar (and they were even going to give her a free steak!). The seminar was about making money without the risk of losing any.
Why would Judy give up on an investment program that had made her so much money over the years? Her 401k showed an 8% average annual return over the past thirty years. Why was she trying to reinvent the wheel? Why was she suddenly questioning a portfolio strategy that worked throughout her adult life?
I’m not sure. This is just how humans operate.
There is always a moment of terror when you realize, “I have to live off of this savings for the rest of my life. I need to be more mindful. I need to watch my account every day and lose sleep when it goes down.”
So Judy goes to a “Free Steak Seminar” and learns about all the wonderful investment options available to her. Before she knows it she is sitting in front of salespeople hell bent on getting her out of those terrible stocks and bonds and put the money somewhere better.
If anyone ever tells you that you can make money when the markets go up and not lose money when they go down — sit back and take a breath. Does that really make sense? What investment company would do that?
So Judy meets with some very nice gentlemen and decides to put her money into an equity indexed annuity. I’m not one to bash other products. Everyone has different needs and different risk tolerances.
But … these things are terrible.
If the market goes up you get a tiny amount of the “up,” and if it goes down you lose nothing. Most of these contracts lock you into ten years. If you want to make a couple percentage points per year, just throw the money into a CD.
I see this all the time. People switch from a diversified portfolio of stocks and bonds, and suddenly get sucked into a new product. Salesmen are very aware of “newly retired” financial fear.
Judy is now in a worse position. Considering this new investment only returns around 2% per year, the reduced income results in a reduced monthly interest check.
In order to join the Retirement Revolution you have to come to terms with this simple fact: You need to invest your money in stocks and bonds. Period. You have to put your trust into something that you don’t entirely understand. You have to deal with the ups and downs. But without the power of these kinds of investments none of this works.
I propose retirees spend “the money the money is making.” This is the absolute core of my message. I suggest using 5% per year. Why? Because if a diversified portfolio of stocks and bonds do not return 5% on average over time it is almost historically unprecedented.
“Spending the money that the money is making” allows you to know exactly how much money you can spend each month. No more and no less. Isn’t that an incredible burden lifted from your shoulders? No more guessing. No more walking around with your hands in the air thinking, “I hope this works; I hope I don’t run out of money.”
Don’t try to reinvent the wheel. You made money in your 401k while working, and you will make money once you’re retired. Don’t give into the fear tactics all around you. Don’t be like Judy who had to take fewer vacations and spoil her grandkids less. Her fear of running out of money actually increased the chances that she would. It is ironic and sad and I witness it constantly.