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Financial Planning The Right Way May 7, 2009

Posted by shaferfinancial in Finance.
Tags: , ,

Today the Saint Petersburg Times ran a column by David Ignatius on the failure of baby boomers to do proper financial planning [Boomers Going Bust, Free membership required to read this column].  The tone of the article was to put the full blame onto the individual with no discussion on the strategies that led to the failure.  Let me address this with a little story.

Bill Mutual and his wife Sally were successful all their lives. They had great jobs and lived a fruitful life raising two children.  Five years before their expected retirement date Bill went to their financial planner for a conference.  He left feeling extremely happy.  They had been investing in mutual funds for the last 25 years of their lives and now had $1.5M in their accounts.  Their advisor told them that they surely will have $2M in their accounts by their retirement date.  He explained they could take 4% of the value each year to live off of and expect to never run out of money.  Bill quickly realized that this would produce $80K per year to live off of.  This along with their social security would give them a healthy $100K in income [fully taxable].  Their dreams of a comfortable retirement were secure, or so he thought.  What his advisor didn’t tell him was that the reason he had that $1.5M was a ten year bull market had driven prices of stocks up to high levels.  In fact, unbeknown to Bill the average price/earning ratio of stocks in his fund was 35, an extremely high number.  18 months later the stock market swooned into a bear market, reducing the value of his funds to $800,000.  Three years later, his expected retirement date, he had managed to get it back up to $1,000,000.   However, he felt that trying to live off of $40K a year + the $20K in social security would be a tight squeeze for their life style so he made a decision to work longer.  Soon after this, his boss brought him into the office and told him the company was laying off folks, so to reduce the pain they were giving packages to the older folks in order to encourage them to retire.  Bill got the message, took the package, and retired.   Just as he thought, it was difficult to live on half his previous earnings, so he got another job.  Two years later he had a series of small strokes, forcing him out of the workforce forever.  Now, during his recuperative phase Bill took out more than his 4% in order to deal with the increased costs due to his illness.  Then Bill did a really dumb thing.  Seeing his nest egg rapidly declining he fell for a scam.  A different “financial advisor” told him he could invest in a high interest rate savings plan that would pay him 10%.  He was told this was FDIC guaranteed.  So Bill took $150K of his money and invested in this scam.  The next year the scam was exposed and his money was gone.  What was once a comfortable retirement had now dwindled down to “barely getting by.”

Now many of you may have guessed that this wasn’t fiction, but was told to me by a gentleman looking for help.  The bear market was the bear of 2000 when stocks went down over 40%.  The scam was centered here in Florida.  The genesis of this sorry story is poor planning from his original “financial planner” who I am sure still doesn’t know why or how he screwed up his client.

Now I have been rereading many of the classics of investing.  They really drive home the mistakes made by Bill and his financial planner.  Here is an alternative financial planning strategy that takes into consideration what we know about investing and risk.

1. 6-9 months cash flow in a money market savings account

2. A life insurance policy with cash value building up

3. Income producing investments which can range from investment real estate to bonds to REITs or limited partnerships

4. Individual stock ownership [to diversify or not is your choice remembering that diversification drops the expected rate of return]

5.  Speculative investing in businesses, real estate, or other types of enterprises [this is only for those who are comfortable with this and have established 1-4 in significant fashion to not have to worry about retirement].

Now here is how this works in retirement.  Since the life insurance cash value never goes negative, if you retire into a bear stock market you can borrow from your policy without severely effecting how long it will last so your first move will be here.  At retirement you arrange to take the income from your income producing assets without having to sell the underlying asset [assuming you have been reinvesting the interest/dividends you have been receiving from these investments up to retirement].  So now you have your first few years retirement income without having to touch your stock investments in a bear market.  When the market comes back up you can choose to either sell all your stocks [selling high is so much better than selling low, isn’t it?] or sell just enough to live on for a few years.  Now you can choose to not borrow from your life insurance policy while you live on your stocks.  Having the option to access cash from different places depending on what the environment looks like is key.  Being able to take some income tax free [from the life insurance policy] also allows you to minimize taxation.  Now here is the key part, if Bill Mutual had set up his finances this way, he likely wouldn’t have panicked and got involved in a scam.  And he would not have had to sell stocks [mutual funds] when they were down.  And ultimately he would have had that comfortable retirement like he dreamed and thought he was going to have.

The bottom line is that the strategies of financial planners not only failed Bill, but are failing most people, and it is just now, as the article in my paper pointed out, becoming apparent.

Contact me now.  Allow me the honor of setting you up with a retirement plan based on “evidence” of what works and doesn’t work instead of theory of how finance should work!



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