Backing Over Retirement

How much money you will have for retirement depends on only two things: How much you have to invest and the return on investment, i.e. Nest egg = Money to invest + Return on investment. When it comes to retirement planning I think people too often treat the size of the nest egg they need and how much they have to invest as given, then back into the return they need to make the numbers work. From there it’s a matter of taking on enough risk to meet those expectations [1].

I think this approach is dangerously backward. For a host of reasons, people tend to devote far too much time to things over which they have little control while ignoring those over which they have sizable control. In investing for retirement it often looks like this (ranked high to low):

Degree of Control

Time Spent

1. Amount spent and saved 1. Return on investment
2. Amount needed to retire 2. Amount needed to retire
3. Return on investment 3. Amount spent and saved

Although it’s psychologically appealing, focusing too much on returns often fails due to one cold, hard fact: The universe and the market don’t give a rat’s ass what return on investment you need. There’s no guarantee you were born at a time and place where the return you need can be achieved by anything other than reckless gambling and luck – and the higher the required return the more luck you’ll need. Even an ostensibly realistic return goal (like 4% per year over the next decade) may not be achievable in practice. The psychological strain of volatile returns can make even conservative goals extremely difficult to achieve, and adding leverage or riskier assets only makes the roller coaster worse.

The better solution is to put yourself in a situation where you need as little return and luck as possible.

1. Save more money each month. Yup, that again. In basic terms return = cash + beta + alpha. There’s an excellent case to be made that alpha approaches zero (typically less than zero) over the long-term, while beta is simply another term for increasing risk, which leaves saving more as the only safe and reliable way to have more money in retirement. It’s not glamorous or exciting – Ray Dalio gets the press, not the person squeezing $5K a year in savings out of a $25K income. Yet a low-income penny pincher is relying more on skill than any stock market wizard, as well as generating a near certain [tax-free] payout. Who’s the genius now?

1a. Get out of debt. Paying off credit card debt can often yield double what Bernie Madoff was promising but with zero risk, guaranteed, in any market environment. What more do you want? You should fire yourself if you miss that trade.

1b. Make more money. I think most people are already sacrificing as much time to the pursuit of money as they can tolerate. However, keep in mind 21st century technology has made it easier than ever before to make money on the side. It’s hard for an old fart like me to believe that spending an hour writing a stupid Facebook app can generate $200 a week in ad revenue, but it can and it all adds up. Keep it at the top of your to do list and don’t rule something out simply because it seems unlikely at first glance. The entire Web 2.0 sector seems ridiculous to me but that hasn’t kept people from making equally ridiculous money from it.

2. Be a true pessimist in your projections.Whether the macro environment smiles or frowns on your investing life, there’s nothing you can do about it except to be unbelievably conservative in your projections about the future. I really do mean unbelievably. In the late 70’s and early 80’s who would have believed <1% money market yields for years on end? If your projections seem comfortably correct, they’re almost certainly wrong. Things will always go wrong, occasionally wildly wrong, so preparing for the worst and hoping for the best is always good financial practice.

3. Redefine retirement. This is the most unexplored avenue to retirement, largely because it goes against the shallow beer commercial portrayal of a life of leisure. Yet taken to the extreme it can allow you to retire tomorrow. Many people have only the vaguest notion of the details of their retirement, mere fragments of a hazy dream. Exactly what do you see yourself doing with your time each day (potentially for decades)? What’s the difference between work and retirement? You need to get paid either way. Is it getting paid by a nameless market rather than a specific person? Is it a matter of choice versus necessity? How much choice you do ever really have? It may not have been featured in your retirement fantasies but you’re going to end up doing something, if only to avoid losing your mind [2], and if you’re doing something why does it always have to be no charge? Help out a former colleague, try something new, be the first 80-year-old guy working at Victoria’s Secret. When you actually get there, I think the odds are high your retirement can produce income from something other than investments, without the constraints of ambition, career and responsibility. Consider it diversification. Is that the stuff of which dreams are made? Maybe not, but it can still be a very satisfying and liberating reality.

If you can generate a high return on your investments, congratulations! But don’t bet the farm and gamble away your nest egg on boosting returns when there are virtually risk-free alternatives. Being a mindless part of the herd is as dangerous when thinking about your retirement as it is in any investing decision. Continually redefining your retirement, your needs, and yourself will always yield a much more interesting life than nodding off in a rocking chair, no matter how great those arthritis pain pills make you feel.


[1] In some cases this strategy be written as: Money to invest * = Needed retirement savings.

[2] The opening scenes with Michael Caine in Harry Brown do a great job of showing how dreary and empty the daily routine of actual retirement can be. More importantly, people who are disconnected from society, without meaning and purpose, tend to die sooner (and I think the downsides of that outweigh any cost savings).


One thought on “Backing Over Retirement

  1. Pingback: Monday links: humbling markets - Abnormal Returns | Abnormal Returns

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