Situation: Let’s use a hypothetical situation to make our case. You’ve retired and sold your house to pay off debts. For many people that would mean that you are now living in a rental that fits your needs and income. In addition, you may have a lot of money left over from the sale of your home and would like to invest it in a prudent manner. But cash is fungible. It can disappear into anything that someone thinks has an equivalent value. (Your minister might think tithing is equivalent, even though you’ve already paid tithing on the income that created your retirement plan.)
As a retiree, you need to develop a budget that will cut your living costs and execute on that plan. Aside from spending money, as directed by your budget, what kind of expenses are going to deplete your nest egg? The main factors to consider are inflation, taxes and transaction costs. There’s little you can do about inflation, other than to stay 50% invested in stocks and 50% in inflation-protected bonds, e.g. inflation-protected 10-Yr Treasury Notes, ISB Savings Bonds and inflation-protected bond funds like Vanguard Inflation-Protected Securities (VIPSX). There’s little you can do about taxes, other than own Treasury Bonds and Savings Bonds (because those pay interest that cannot be taxed by the state where you live). Also, you can avoid both Federal and state taxes by owning municipal bonds issued in the state where you live. But that is risky unless you happen to live in one of the 7 states that offer a AAA bond with investor-friendly covenants. You might also consider a low-cost, state-specific municipal bond fund if you live in a populous state that is in good fiscal condition and has a AAA credit rating, but Florida is the only state that fits that description.
Now we’re left to talk about transaction costs. You’ll like doing business with the US Treasury over the internet because there are no transaction costs. But with stocks, it gets more complicated. To reduce transaction costs, there are two routes you can take: 1) Invest in low-cost mutual funds. Vanguard Group has the best deals. Avoid Exchange-Traded Funds unless you want to throw a little business to your stock-broker in return for the research materials she’s been providing. 2) Make low-cost investments online, monthly and automatically. You can do this with any of the Vanguard mutual funds but also with individual stocks. There are 3 main websites: Computershare, Wells Fargo, and American Stock Transfer & Trust.
Mission: Set up a spreadsheet (see Table) with metrics for a sample of stocks that are available for dollar-cost averaging (monthly and online using automatic withdrawals from your checking account). Pick examples from a single source (Computershare) and list the annual transaction cost for investing $100/mo. Balance stocks with 10-Yr Treasury Notes obtained through TreasuryDirect. Inflation-protected versions of those Notes are available, as are IRA-like versions called ISBs (Inflation-Protected Savings Bonds). Those fixed-income assets need to represent 1/3rd of your monthly investment, stocks from each of the 4 S&P Defensive Industries 1/3rd, and stocks from each of the 4 S&P Growth Industries 1/3rd.
In the BENCHMARKS section, include low-cost mutual funds referencing a Standard Retirement Plan. NOTE: The 4 S&P Defensive Industries are Utilities, HealthCare, Communication Services and Consumer Staples. The 4 S&P Growth Industries are Financials, Information Technology, Industrials and Consumer Discretionary. The two commodity-related Industries (Basic Materials and Energy) are omitted. Why? Because even the few A-rated stocks have excess volatility. As a retiree, investing in those Industries would amount to gambling with your “nest egg.”
Execution: see Table.
Bottom Line: Transaction costs consume 2.5%/yr of most investor’s savings. But the internet allows you to reduce transaction costs to less than 1%/yr. Over a 10 yr holding period, that 1.5% difference would increase your return on a $10,000 investment by $1,600. In Column U of this week’s Table, we show that if you pick a dozen high-quality stocks and bonds from the main internet sources, and automatically invest $100/mo in each, your annual expenses would come to ~$135 for that investment of $12,000 (0.94%). But read the fine print first:
Caveat emptor: Owning individual stocks is a gamble unless a) you own at least 30 stocks, and b) your picks reflect the impact of each S&P Industry on the economy. Otherwise, you’ll lose money at some point because of selection bias. To avoid that risk altogether, invest in stock index funds that cover the entire economy, e.g. the Vanguard 500 Index Fund (VFINX), the Vanguard Total Stock Market Index Fund (VTSMX), and the SPDR S&P MidCap 400 ETF (MDY).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: In dollar-average into UNP, JNJ, T, NKE and KO, as well as ISBs (Inflation-Protected Savings Bonds).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 20.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Showing posts with label reverse mortgage. Show all posts
Showing posts with label reverse mortgage. Show all posts
Sunday, February 19
Sunday, January 22
Week 291 - Back-up Your Rainy Day Fund With A-rated Defensive Stocks That Are Dividend Achievers With Clean Balance Sheets
Situation: After retirement, you’ll have a stream of fixed income, ideally from several sources, namely annuities, a pension or Reverse Mortgage, Social Security, an IRA, a 401(k) or 403(b), and RMDs (Required Minimum Distributions) on any of those you haven’t converted to annuities. For 30-40% of you, Social Security and perhaps a Reverse Mortgage will be the extent of your retirement income. You’ll budget that income, perhaps with the help of Food Stamps. But also need to have an FDIC-insured Savings Account for emergencies. That Rainy Day Fund will be eroded by inflation, travel, and non-recurring capital expenditures, mainly co-payments and deductibles on your health insurance. To keep ahead of inflation, we recommend that you stuff your Rainy Day Fund with Inflation-Protected Savings Bonds (ISBs), which currently yield 2.76%. You can cash those bonds in after 5 yrs without incurring a penalty, but would lose only one interest payment if you were to cash in earlier.
The money you take out of your Rainy Day Fund has to be replaced, so as to have at least a one-year year buffer, i.e., in order to keep it from disappearing. Those replacement dollars will have to come from a part-time job, renting out a room in your house, or severe budgeting. But there is a better way, which is to arrange (before you retire) to have a growing income. To help achieve this, back up your Rainy Day Fund by investing in “defensive” stocks, using the cheapest way possible, which is to purchase shares online and use “dollar-cost averaging” via automatic withdrawals from your checking account--into stocks of one or two companies among S&P’s defensive industries. These are: Health Care, Utilities, Consumer Staples, and Telecommunication Services.
Mission: Set up a spreadsheet of A-rated Dividend Achievers in the 4 S&P defensive industries.
Administration: This week’s Table has 8 such Dividend Achievers, and the shares of all but Procter & Gamble (PG) and McCormick (MKC) can be purchased from Computershare; PG and MKC shares are offered by Wells & Fargo. The annual cost of investing $100/mo online in each is shown in Column AB of the Table. The average cost for investing $1200/yr in monthly installments is $8.00, giving an Expense Ratio of 0.67% (8/1200). There are also exchange-traded funds (ETFs) available for each S&P Industry but those would need to be purchased through a broker. The average dividend yield for all 8 is a little less than 3% (see Column G in the Table), and the average long-term price appreciation of the stocks is ~9.5% (see Column K in the Table). All 8 have less risk of loss in the next Bear Market than the S&P 500 Index (see Column M in the Table).
Bottom Line: After you retire, your only sources of income growth are Social Security and dividend-paying stocks. The best way to safely capture dividend growth is to invest in a low-cost managed mutual fund like Vanguard Wellesley Income Fund (VWINX), where the managers mainly use safe bonds but thread in dividend-paying stocks to represent 30-40% of assets. The next best way is to have a computer hold stocks at 60% and bonds at 40%, e.g. the Vanguard Balanced Index Fund (VBINX). Finally, if you have the time and interest, pick relatively safe “defensive” stocks on the basis of dividend growth (see Column H in the Table) and historically low volatility (see Column M in the Table). Today’s blog focuses on that option.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG, JNJ and NEE, and also own shares of KO, WMT, ABT and MKC.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 17.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The money you take out of your Rainy Day Fund has to be replaced, so as to have at least a one-year year buffer, i.e., in order to keep it from disappearing. Those replacement dollars will have to come from a part-time job, renting out a room in your house, or severe budgeting. But there is a better way, which is to arrange (before you retire) to have a growing income. To help achieve this, back up your Rainy Day Fund by investing in “defensive” stocks, using the cheapest way possible, which is to purchase shares online and use “dollar-cost averaging” via automatic withdrawals from your checking account--into stocks of one or two companies among S&P’s defensive industries. These are: Health Care, Utilities, Consumer Staples, and Telecommunication Services.
Mission: Set up a spreadsheet of A-rated Dividend Achievers in the 4 S&P defensive industries.
Administration: This week’s Table has 8 such Dividend Achievers, and the shares of all but Procter & Gamble (PG) and McCormick (MKC) can be purchased from Computershare; PG and MKC shares are offered by Wells & Fargo. The annual cost of investing $100/mo online in each is shown in Column AB of the Table. The average cost for investing $1200/yr in monthly installments is $8.00, giving an Expense Ratio of 0.67% (8/1200). There are also exchange-traded funds (ETFs) available for each S&P Industry but those would need to be purchased through a broker. The average dividend yield for all 8 is a little less than 3% (see Column G in the Table), and the average long-term price appreciation of the stocks is ~9.5% (see Column K in the Table). All 8 have less risk of loss in the next Bear Market than the S&P 500 Index (see Column M in the Table).
Bottom Line: After you retire, your only sources of income growth are Social Security and dividend-paying stocks. The best way to safely capture dividend growth is to invest in a low-cost managed mutual fund like Vanguard Wellesley Income Fund (VWINX), where the managers mainly use safe bonds but thread in dividend-paying stocks to represent 30-40% of assets. The next best way is to have a computer hold stocks at 60% and bonds at 40%, e.g. the Vanguard Balanced Index Fund (VBINX). Finally, if you have the time and interest, pick relatively safe “defensive” stocks on the basis of dividend growth (see Column H in the Table) and historically low volatility (see Column M in the Table). Today’s blog focuses on that option.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG, JNJ and NEE, and also own shares of KO, WMT, ABT and MKC.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 17.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 15
Week 289 - Don't Leave Federal "Tax Expenditures" On The Table
Situation: There are 5 Federal government programs that can reduce your cost of living in retirement. You need to learn about these and take advantage of them whenever you are likely to benefit.
Program #1: The Social Security Act of 1935: You need to decide when to retire, because each year you delay results in an 8% larger Social Security check. You also need to brush up on other aspects of The Social Security Act that apply to you or your family. If you and your husband are divorced, and you’ve never remarried, you may still be eligible for some additional benefits. Check out the SSA website for answers to questions, and visit your nearest SSA office to get the help that you might need.
Program #2: Social Security Act Amendments of 1965 (Medicare): When you enroll in Medicare at age 65, you’ll have the option of taking out private “MediGap” insurance, which is supervised by your state government, or enrolling in Part C, which is a private “Medicare Advantage” plan that is a Federally-managed and “capped” supplement encompassing Parts A and B of Medicare.
Program #3: The Housing and Community Development Act of 1987 provides insurance for FHA Home Equity Conversion Mortgages (HECM), known as “reverse mortgages”. More than 3/4ths of the average retirees’ net worth is tied up in home equity, with other sources averaging ~$45,000 for Americans in the 65 to 69 year age group. By following the 4% Rule, the average American can only spend $150/mo of that “nest egg” to supplement her income from Social Security. To keep up with the myriad expenses of home ownership, she’ll have to decide whether to get a part-time job, sell her house, rent out part of it, or enter into a reverse mortgage. “Reverse mortgages are increasing in popularity with seniors who have equity in their homes and want to supplement their income. The only reverse mortgage insured by the U.S. Federal Government is called a Home Equity Conversion Mortgage or HECM, and is only available through an FHA approved lender.” But there is evidence that the average American is preparing better for retirement: As of 2015, those between the ages of 55 and 64 had saved an average of $104,000 according to the Government Accountability Office, which means $217/mo could be spent without eliminating that nest egg.
Program #4: The Cigar Excise Tax Extension Act of 1960 provides the legal framework for Real Estate Investment Trusts or REITs. This law does not create a tax expenditure (subsidy). Instead, it raises more revenue by creating an incentive for investors to move their money into real estate. That indirectly helps to reduce your cost of living at an extended care facility, when you can no longer live independently. Unless you are well off, you won’t be able to afford private long-term care insurance, and Federally subsidized long-term care insurance is only available to retired Federal employees. REITs are a partial solution, because they free real estate companies from paying Federal taxes, leaving investors with the obligation to pay that tax. REITs are similar to mutual funds except that they’re required to pay at least 90% of their income to investors, as dividends. Those dividends are attractive enough that REITs now have a large following among investors. Many “nursing homes” and extended care facilities are REITs. Retirees benefit from the capitalization structure of healthcare REITs, but investors who can tolerate a “roller-coaster ride” also come out ahead.
Program #5: The Food Stamp Act of 1964: Your next decision is whether or not to apply for food stamps. If you have no other source of income than Social Security, you are definitely eligible.
Mission: Set up a spreadsheet of ways an investor might invest in some of the public-private partnerships listed above, including health insurance companies that offer MediGap and Medicare Advantage plans. Pay particular attention to healthcare REITs.
Execution: see Table.
Bottom Line: Once you retire, your annual income will not keep up with inflation. With each passing year, you’ll become a little more watchful of spending and a little more likely to search out discounts. You’ll start to inquire about Federal programs that are particularly helpful to retirees, e.g. Food Stamps. We’ve listed 5 Federal programs that benefit retirees; you should become conversant in these before you retire. We have also listed 6 companies in the Table; 3 are healthcare REITs and 3 are large insurance companies with MediGap or Medicare Advantage plans. All 6 are high-risk high-reward businesses.
Risk Rating: 7 (where US Treasuries = 10, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I don’t own shares in any of the 6 companies listed in the Table, but am looking to buy shares in the only “blue chip” (Dow Jones Industrial Average company): UnitedHealth Group (UNH).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Program #1: The Social Security Act of 1935: You need to decide when to retire, because each year you delay results in an 8% larger Social Security check. You also need to brush up on other aspects of The Social Security Act that apply to you or your family. If you and your husband are divorced, and you’ve never remarried, you may still be eligible for some additional benefits. Check out the SSA website for answers to questions, and visit your nearest SSA office to get the help that you might need.
Program #2: Social Security Act Amendments of 1965 (Medicare): When you enroll in Medicare at age 65, you’ll have the option of taking out private “MediGap” insurance, which is supervised by your state government, or enrolling in Part C, which is a private “Medicare Advantage” plan that is a Federally-managed and “capped” supplement encompassing Parts A and B of Medicare.
Program #3: The Housing and Community Development Act of 1987 provides insurance for FHA Home Equity Conversion Mortgages (HECM), known as “reverse mortgages”. More than 3/4ths of the average retirees’ net worth is tied up in home equity, with other sources averaging ~$45,000 for Americans in the 65 to 69 year age group. By following the 4% Rule, the average American can only spend $150/mo of that “nest egg” to supplement her income from Social Security. To keep up with the myriad expenses of home ownership, she’ll have to decide whether to get a part-time job, sell her house, rent out part of it, or enter into a reverse mortgage. “Reverse mortgages are increasing in popularity with seniors who have equity in their homes and want to supplement their income. The only reverse mortgage insured by the U.S. Federal Government is called a Home Equity Conversion Mortgage or HECM, and is only available through an FHA approved lender.” But there is evidence that the average American is preparing better for retirement: As of 2015, those between the ages of 55 and 64 had saved an average of $104,000 according to the Government Accountability Office, which means $217/mo could be spent without eliminating that nest egg.
Program #4: The Cigar Excise Tax Extension Act of 1960 provides the legal framework for Real Estate Investment Trusts or REITs. This law does not create a tax expenditure (subsidy). Instead, it raises more revenue by creating an incentive for investors to move their money into real estate. That indirectly helps to reduce your cost of living at an extended care facility, when you can no longer live independently. Unless you are well off, you won’t be able to afford private long-term care insurance, and Federally subsidized long-term care insurance is only available to retired Federal employees. REITs are a partial solution, because they free real estate companies from paying Federal taxes, leaving investors with the obligation to pay that tax. REITs are similar to mutual funds except that they’re required to pay at least 90% of their income to investors, as dividends. Those dividends are attractive enough that REITs now have a large following among investors. Many “nursing homes” and extended care facilities are REITs. Retirees benefit from the capitalization structure of healthcare REITs, but investors who can tolerate a “roller-coaster ride” also come out ahead.
Program #5: The Food Stamp Act of 1964: Your next decision is whether or not to apply for food stamps. If you have no other source of income than Social Security, you are definitely eligible.
Mission: Set up a spreadsheet of ways an investor might invest in some of the public-private partnerships listed above, including health insurance companies that offer MediGap and Medicare Advantage plans. Pay particular attention to healthcare REITs.
Execution: see Table.
Bottom Line: Once you retire, your annual income will not keep up with inflation. With each passing year, you’ll become a little more watchful of spending and a little more likely to search out discounts. You’ll start to inquire about Federal programs that are particularly helpful to retirees, e.g. Food Stamps. We’ve listed 5 Federal programs that benefit retirees; you should become conversant in these before you retire. We have also listed 6 companies in the Table; 3 are healthcare REITs and 3 are large insurance companies with MediGap or Medicare Advantage plans. All 6 are high-risk high-reward businesses.
Risk Rating: 7 (where US Treasuries = 10, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I don’t own shares in any of the 6 companies listed in the Table, but am looking to buy shares in the only “blue chip” (Dow Jones Industrial Average company): UnitedHealth Group (UNH).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 25
Week 286 - Should You Take Out A Reverse Mortgage?
Situation: Young couples are often advised to make payments each month on 1) a home mortgage, and 2) a “whole life” insurance policy. Homes are not good investments, and neither are “whole life” policies. They’re a form of compelled savings. If we later find ourselves unprepared for retirement, we may be guided to recoup those savings by “taking out” a reverse mortgage or “borrowing against” a whole life policy. The government joins the party by compelling us to save during our working years (under the Federal Insurance Contributions Act of 1935), and then guides us to recoup our “Social Security” savings in retirement.
Mission: Look at the costs and benefits of reverse mortgages. NOTE: To obtain more detailed information, I suggest reading this article that appeared in USA Today on October 28.
Execution: “On the plus side, reverse mortgages are considered loan advances to you, not income you earned. Thus, the payments you receive are not taxable. Moreover, they usually don't affect your Social Security or Medicare benefits.” Emotional benefits play a role, given that 1) you get to keep living in your home without paying rent, and 2) your children get to inherit a house that retains considerable equity. And, reverse mortgages make a great Rainy Day Fund.
On the negative side, there is “opportunity cost”: You are giving up the opportunity to invest a large sum of your own money, if you sell the house and rent a place more suited to your needs. Transaction costs on the sale are the same as those for taking out a reverse mortgage (6%), which leaves 94% for you to invest. We provide an example (see Table) of how you might set up an online investment in bonds and stocks that pays out at least 2%/yr (after transaction costs) and grows those payments at least 2%/yr.
Administration: The investment example has an asset allocation of 50% bonds/50% stocks. The bonds are “zero risk/zero cost” 10-Yr Treasury Notes accessed through the government website; that site also offers inflation-protected Treasury Notes. You can invest in KO, JNJ and WMT online but have to use a different website to invest in PG. Each pays a good and growing dividend, and had Total Returns/yr during the Housing Crisis that were better than those for our key benchmark, the Vanguard Balanced Index Fund (VBINX; see Column D in the Table).
It is best to make these investments over time, starting with 40% of your proceeds then adding $100/mo to each of the 4 stocks and $1200/qtr to T-Notes. So, 60% of the proceeds from selling your house would initially go to an FDIC-insured savings account paying little interest. Part of that 60% will never be invested because it serves as your Rainy Day Fund. Nonetheless, you’ll be in a position to withdraw $9600/yr for electronic transfers to bond and stock accounts. Annual transaction costs come to ~$72/yr (see Column N in the Table).
Bottom Line: Reverse mortgages can be a good idea, if you’ve paid off your home mortgage and have almost no source of retirement income outside of Social Security. But inflation will always be with us, so it might be better to sell your house and move to a place that is not designed for raising children. Then, you can invest the proceeds from selling your house in a manner that costs you little and provides an opportunity to protect yourself from inflation.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG and JNJ, as well as inflation-protected Savings Bonds (which are an IRA-like version of 10-Yr Treasury Notes). I also own shares of KO and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Look at the costs and benefits of reverse mortgages. NOTE: To obtain more detailed information, I suggest reading this article that appeared in USA Today on October 28.
Execution: “On the plus side, reverse mortgages are considered loan advances to you, not income you earned. Thus, the payments you receive are not taxable. Moreover, they usually don't affect your Social Security or Medicare benefits.” Emotional benefits play a role, given that 1) you get to keep living in your home without paying rent, and 2) your children get to inherit a house that retains considerable equity. And, reverse mortgages make a great Rainy Day Fund.
On the negative side, there is “opportunity cost”: You are giving up the opportunity to invest a large sum of your own money, if you sell the house and rent a place more suited to your needs. Transaction costs on the sale are the same as those for taking out a reverse mortgage (6%), which leaves 94% for you to invest. We provide an example (see Table) of how you might set up an online investment in bonds and stocks that pays out at least 2%/yr (after transaction costs) and grows those payments at least 2%/yr.
Administration: The investment example has an asset allocation of 50% bonds/50% stocks. The bonds are “zero risk/zero cost” 10-Yr Treasury Notes accessed through the government website; that site also offers inflation-protected Treasury Notes. You can invest in KO, JNJ and WMT online but have to use a different website to invest in PG. Each pays a good and growing dividend, and had Total Returns/yr during the Housing Crisis that were better than those for our key benchmark, the Vanguard Balanced Index Fund (VBINX; see Column D in the Table).
It is best to make these investments over time, starting with 40% of your proceeds then adding $100/mo to each of the 4 stocks and $1200/qtr to T-Notes. So, 60% of the proceeds from selling your house would initially go to an FDIC-insured savings account paying little interest. Part of that 60% will never be invested because it serves as your Rainy Day Fund. Nonetheless, you’ll be in a position to withdraw $9600/yr for electronic transfers to bond and stock accounts. Annual transaction costs come to ~$72/yr (see Column N in the Table).
Bottom Line: Reverse mortgages can be a good idea, if you’ve paid off your home mortgage and have almost no source of retirement income outside of Social Security. But inflation will always be with us, so it might be better to sell your house and move to a place that is not designed for raising children. Then, you can invest the proceeds from selling your house in a manner that costs you little and provides an opportunity to protect yourself from inflation.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG and JNJ, as well as inflation-protected Savings Bonds (which are an IRA-like version of 10-Yr Treasury Notes). I also own shares of KO and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 16
Week 15 - Retirement on a Shoestring: The Rainy Day Fund
Situation: A middle-income worker reaches age 50 without a pension, 401(k), or 403(b) plan. She’ll need to put aside the maximum amount allowed ($6,000/yr) into a Roth IRA. In addition, it would be smart to start a “Rainy Day Fund” (~$1,200/yr) to protect the Roth IRA from being depleted in the event of illness or unemployment.
Goal: Determine how much money would be in the proposed Roth IRA and Rainy Day Funds (started at age 50) upon approaching a retirement age of 65, using the lowest expenses and least risky investments.
Everyone needs to have a Rainy Day Fund as the first line of defense for economic well being. It needs to be readily available without paying significant penalty fees for early withdrawal (aside from taxes due). Such a fund should contain enough to pay 6 months of basic expenses. Most people use a savings account but here at ITR we advocate for something a little more remunerative. Consider a fund that balances stocks and bonds 50:50.
On the bond side, the Inflation-protected Savings Bond (ISB) is hard to beat. It is the benchmark for “net net net investing” (i.e., total return after expenses, inflation, and taxes). An ISB has no up-front expenses (and you know from our prior blogs that is a big point). To purchase yours, go to Treasurydirect and set up electronic withdrawals from your bank account. ISBs pay a fixed rate of interest but also add principal in direct proportion to inflation. There are no taxes on an ISB until you cash it in, typically at a time of minimal tax liability, ideally, after retirement. Invest at least $50/mo until you have enough ISBs to cover 3 months of living expenses. A small fee is assessed if you withdrawal your money prior to 5 years after purchase (you pay 3 months worth of interest income).
To cover the remaining 3 months of expenses, invest at least $50/mo in a Lifeboat Stock with a low beta and high dividend. Abbott Laboratories (ABT) meets those requirements and setting up your DRIP using Computershare is user-friendly. There are no fees for an automatic investment plan of as little as $10/mo. [There is one significant inconvenience: the initial shares need to be purchased through a stock broker and transferred electronically to Abbott Laboratories for registration in your name.] Other DRIPs to consider include Johnson & Johnson (JNJ), Procter & Gamble (PG), and Wal*Mart (WMT). Most of those DRIPs charge ~$1/mo but do not require you to register shares through a stock broker.
Once you have your Rainy Day Fund and Roth IRA (review Week 14) on autopilot, you will breathe a little easier. Now you can take an active interest in the rest of your retirement preparations, namely, paying off your obligations which for most people is a mortgage. This will leave you well positioned for starting a reverse mortgage at age 65. We also recommend taking an active approach to keeping your job skills tuned up by taking one evening class per semester at a local community college. This allows the maximum level of flexibility for remaining competitive in your current job, or finding a new job if that (unhappy) situation should arise.
We have attached a Spreadsheet summarizing the investment options mentioned for establishing a Roth IRA (Week 14) and a Rainy Day Fund. ISBs did not become available until 1999, so the history of transactions is shorter than what we’ve used in other examples. But if the total return for that shortened period (3.33%/yr) were to be applied for the same 14.7 yr period as our other examples, the total amount invested would be $8,850 (same as for ABT) and the ending value would be $11,587 instead of the $9,241 listed in the spreadsheet. That would bring the total ending value for the Rainy Day Fund to $24,966 after 14.7 yrs (total return = 4.16%/yr). Since the ending value for the proposed Roth IRA is $155,955, the total savings for retirement equals $180,921. That money could be used, for example, to purchase a fixed annuity paying over $1,000/mo beginning at age 65 in today’s dollars. Alternatively, you could just cease paying the $7,200/yr and draw the annual dividend and interest income from that $180,921 (i.e., $6,107/yr, or $509/mo). That payout would continue to grow ~4%/yr faster than inflation while leaving the principal untouched. Taxes would only be due on expenditures from the Rainy Day Fund. Social Security would likely add >$2,000/mo to your retirement income, which amount is partly taxable but also keeps up with inflation.
Let’s face it, $2,600+ a month doesn’t go very far even if it is protected from inflation and taxes. This is why setting up a reverse mortgage and continuing to work will become important options to have available for fine-tuning your retirement income.
Bottom Line: Retirement is perilous. Plan ahead. It’s later than you think.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Goal: Determine how much money would be in the proposed Roth IRA and Rainy Day Funds (started at age 50) upon approaching a retirement age of 65, using the lowest expenses and least risky investments.
Everyone needs to have a Rainy Day Fund as the first line of defense for economic well being. It needs to be readily available without paying significant penalty fees for early withdrawal (aside from taxes due). Such a fund should contain enough to pay 6 months of basic expenses. Most people use a savings account but here at ITR we advocate for something a little more remunerative. Consider a fund that balances stocks and bonds 50:50.
On the bond side, the Inflation-protected Savings Bond (ISB) is hard to beat. It is the benchmark for “net net net investing” (i.e., total return after expenses, inflation, and taxes). An ISB has no up-front expenses (and you know from our prior blogs that is a big point). To purchase yours, go to Treasurydirect and set up electronic withdrawals from your bank account. ISBs pay a fixed rate of interest but also add principal in direct proportion to inflation. There are no taxes on an ISB until you cash it in, typically at a time of minimal tax liability, ideally, after retirement. Invest at least $50/mo until you have enough ISBs to cover 3 months of living expenses. A small fee is assessed if you withdrawal your money prior to 5 years after purchase (you pay 3 months worth of interest income).
To cover the remaining 3 months of expenses, invest at least $50/mo in a Lifeboat Stock with a low beta and high dividend. Abbott Laboratories (ABT) meets those requirements and setting up your DRIP using Computershare is user-friendly. There are no fees for an automatic investment plan of as little as $10/mo. [There is one significant inconvenience: the initial shares need to be purchased through a stock broker and transferred electronically to Abbott Laboratories for registration in your name.] Other DRIPs to consider include Johnson & Johnson (JNJ), Procter & Gamble (PG), and Wal*Mart (WMT). Most of those DRIPs charge ~$1/mo but do not require you to register shares through a stock broker.
Once you have your Rainy Day Fund and Roth IRA (review Week 14) on autopilot, you will breathe a little easier. Now you can take an active interest in the rest of your retirement preparations, namely, paying off your obligations which for most people is a mortgage. This will leave you well positioned for starting a reverse mortgage at age 65. We also recommend taking an active approach to keeping your job skills tuned up by taking one evening class per semester at a local community college. This allows the maximum level of flexibility for remaining competitive in your current job, or finding a new job if that (unhappy) situation should arise.
We have attached a Spreadsheet summarizing the investment options mentioned for establishing a Roth IRA (Week 14) and a Rainy Day Fund. ISBs did not become available until 1999, so the history of transactions is shorter than what we’ve used in other examples. But if the total return for that shortened period (3.33%/yr) were to be applied for the same 14.7 yr period as our other examples, the total amount invested would be $8,850 (same as for ABT) and the ending value would be $11,587 instead of the $9,241 listed in the spreadsheet. That would bring the total ending value for the Rainy Day Fund to $24,966 after 14.7 yrs (total return = 4.16%/yr). Since the ending value for the proposed Roth IRA is $155,955, the total savings for retirement equals $180,921. That money could be used, for example, to purchase a fixed annuity paying over $1,000/mo beginning at age 65 in today’s dollars. Alternatively, you could just cease paying the $7,200/yr and draw the annual dividend and interest income from that $180,921 (i.e., $6,107/yr, or $509/mo). That payout would continue to grow ~4%/yr faster than inflation while leaving the principal untouched. Taxes would only be due on expenditures from the Rainy Day Fund. Social Security would likely add >$2,000/mo to your retirement income, which amount is partly taxable but also keeps up with inflation.
Let’s face it, $2,600+ a month doesn’t go very far even if it is protected from inflation and taxes. This is why setting up a reverse mortgage and continuing to work will become important options to have available for fine-tuning your retirement income.
Bottom Line: Retirement is perilous. Plan ahead. It’s later than you think.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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