by Greg Hartz
The practice of working until you were no longer able began to change roughly 150 years ago.
Some of the early pension programs around the world were started in order to “retire” older, less productive workers. In 1875, the American Express Company started the first private pension offering as a way for employers to incent older workers to leave. For the last 150 years or so, the developed world has struggled with how to finance life after work. Everyone wants the magic formula that will assure a financially sound retirement.
Consider the following to give you the best chance for maintaining a standard of living in retirement that is consistent with your means:
There Is No Magic Formula
Many of the factors that determine a financially sound retirement like investment returns, inflation, life expectancies, technological changes and others are in the future. Knowing how, when and how much to save for retirement is an exercise in the unknowable. Recognizing that fact should instill a sober and realistic mindset in managing your retirement planning. As we do in selecting investment securities for our clients’ portfolios, we recommend establishing a conservative margin for error when making the key assumptions that impact your plan.
Start Early
The money stashed away and invested early in one’s life is the most important and powerful money in forming family capital and building toward a soundly financed retirement. Let the power of compounded earnings work for you. Educate the young members of your family about the importance of early saving. We find that fewer and fewer people with whom we come in contact have been taught this early life lesson.
Live Beneath Your Means
Living reasonably beneath your means helps you to save and eliminate debt on your personal balance sheet. Personal debt should be paid off as soon as possible in spite of the fact (or maybe because of it) that studies have shown interest rates are lower now than at any time in 5,000 years of recorded history. If you are fortunate enough to receive unexpected windfalls such as bonuses, salary increases or gifts of money, use them to retire debt or add to savings.
Prioritize debt retirement once you have established a rainy-day fund of six months’ worth of expenses. Saving and retiring debt are not easy, so “pay yourself” first by saving on the front end and basing your budget on the funds available after your savings goal has been met. Being free from the pressures associated with debt allows you to make better long-term financial decisions.
Maximize Tax Advantaged Retirement Savings
Use tax sheltered savings accounts to the fullest extent possible. If you receive a matching contribution from your employer, it usually is beneficial to maximize your contributions to such a plan before establishing individual retirement accounts. Roth 401k plans and Roth IRAs (for those eligible) are very powerful, especially for young people just starting out. As you build your retirement savings and eliminate debt, make a goal of having significant savings outside of tax-sheltered structures.
Leaving your tax-deferred retirement investments to compound until the government requires you to take distributions is a great advantage. In order to take advantage of this opportunity, you will need funds to sustain you from the day you retire until the day Uncle Sam requires you to take distributions from your tax-deferred retirement account (not required in the case of Roth accounts).
Investing for Retirement
One could do no better than Sir John Templeton’s 16 Rules for Investment Success. Templeton was a highly successful value investor who brought the idea of investing globally to the public through his Templeton funds.
His rules are as follows (with my own parenthetical comments): 1. Invest for maximum total real return (after inflation); 2. Invest, don’t trade or speculate; 3. Remain flexible and open-minded about types of investment (including real estate and small businesses); 4. Buy low; 5. When buying stocks, search for bargains among quality stocks; 6. Buy value, not market trends or the economic outlook; 7. Diversify (in stocks and bonds, there is safety in numbers); 8. Do your homework or hire wise (and experienced) experts to help you; 9. Aggressively monitor your investments (though he probably didn’t mean minute by minute or even daily); 10. Don’t panic (remember 2008 and early 2009?); 11. Learn from your mistakes; 12. Begin with a prayer (this should have been rule No. 1!); 13. Outperforming the market is a difficult task (and maybe not even your proper objective, especially in the short and intermediate term); 14. An investor who has all the answers doesn’t even understand all the questions (one of my favorites…recognizing and admitting to yourself what you don’t know is vastly important); 15. There’s no free lunch (avoid trying to make easy, fast money); 16. Do not be fearful or negative too often (again, remember 2008 and early 2009).
Templeton’s rules are available online. I highly recommend reading them. In his first rule, he emphasizes the importance of recognizing inflation. Expanding on this is very important in the current environment; inflation is occurring at a significant rate, though the U.S. government and the Federal Reserve would like you to believe otherwise. We believe the rate of inflation is immeasurable. Today, inflation is mostly manifesting itself not so much in “cost of living” but in asset prices, particularly bonds, and many stocks as well. We see most business valuations in both public and private equity markets as being through the roof and unlikely to be sustained.
The Federal Reserve opened a Pandora’s box when it successfully created a “wealth effect” during and following the “Great Financial Crisis.” It has been trying to sustain that ever since, and recently resumed practices similar to those taken during that crisis in an effort to keep short-term interest rates low. However, large federal government deficit financings are creating upward rate pressures in those markets. In trying to keep a lid on short-term interest rates, the Federal Reserve once again has become the buyer of last resort, at least for the time being. As we assess the current monetary and market environments (see Templeton’s rule 16), we’re not fearful or negative.
The equity market right now doesn’t provide a lot of opportunity to practice rule 4 or rule 6; perhaps now you can see why we say rule 12 — begin with a prayer — should have been No. 1.
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Greg Hartz, CPA, CFA, is the founding partner of Foundation Resource Management, an independent, value-based investment advisory firm in Little Rock.
