Retirement Isn’t the End of Investing

Paul Winkler: Welcome. This is “The Investor Coaching Show,” and I am Paul Winkler.

Now, there’s a conversation I had this week, and I thought I would share a little bit.

A non-listener of the show—so it wouldn’t be somebody that had picked up a lot of the stuff that I teach here or had necessarily gotten into any of the education that we do in our offices as well. So it makes it fun just to talk about.

The reality is sometimes people listen to the show, or they’ve been through—we work with investors, and we teach them as much as we possibly can before giving any advice.

But let’s face it, it doesn’t necessarily stick. A lot of times you’ll learn something, and then you forget about 80%.

If you’ve ever seen those studies, they show how much of what you’ve learned that actually stayed with you after one day, after two days, after three days, after a week. It’s just horrible.

So I recognize that I do this every day. And for me to remember things, it’s nothing, because I do it every day.

I teach it every day.

And the reality is, it’s not what you do. Unless you’re listening and you do do this, but most people, it’s not what you do.

Planning for Income in Retirement

So the issue was about taking income in retirement. Typically, what do you think?

You get to retirement, and you go, “Okay. I’m going to retire in five years. I’m going to retire in 10 years.” Or whatever.

And you think, I’ve got 10 years, and that’s going to be my time horizon.

Well, no, actually. If you’re going to retire in five years—and let’s say you’re age 60, you’re going to retire at 65 or something like that—your time horizon might be 35 years.

So it’s a whole different deal. You’ve got to be thinking way, way longer term because you’re not going to get out five years and then just stick it all in cash and see how long it can last.

Because the reality of it is, when you put all your money in cash—and let’s say you’re taking a 5% distribution or something like that.

Well, it might be 20 years later, all the money’s gone.

Less than that if you’re taking an inflation increase every year. Especially seeing as interest rates are next to nothing.

And you take, let’s say, a million dollars. You’re taking $50,000, and your interest rate is a half a percent or whatever.

As you can imagine, if you’re starting at $50,000, and over 20 years, you need to increase your distribution by 50%. I mean, look at the inflation rate over the past 20 years, and now you need $75,000 to buy what $50,000 used to buy.

So the reality of it is, you’re actually taking out—I guess, what do we make that? So about $50,000, a little bit over $60,000, $62,500 I guess, average per year over 20 years—so $1.3 million, I don’t know. I’m just trying to do this math in my head.

I’m thinking, you’re taking about $1.3 million out of a million dollar portfolio that’s not earning hardly any interest. It doesn’t take a rocket scientist to figure out that you’re probably going to run it out in 20 years.

You May Live Longer Than You Think

And the reality of it is, if you’ve got a husband or wife, they might have a 30-plus-year time horizon. I mean, the math just doesn’t work.

You’re going to literally be going, “Oh, crud. I’m running out of money. I haven’t run out of life like I thought.”

People often say that. I hear that.

“Ah. I’ll probably only live this long.”

And I go, well, the reality of it is you probably will end up living longer than you think you will, just because of the fact that people don’t realize. They don’t think about how medical science is stretching our life expectancies significantly.

We had a little bit of a bump in the road a couple years ago, and there was a decrease in our life expectancies temporarily, but that’s probably just going to be a temporary bump in the road really, when it gets down to it.

So what happens is people say, “Well, I need to make sure that I have this money last, and I can’t dip below the principle,” is what goes through their mind.

Should You Be Concerned About Your Principal?

There are all kinds of people out there saying, “Hey, we’ve got this investment product for you. It won’t dip below the principle.”

I’ve heard people come in and say, “They said they would pay me a 4% return, 5% return.”

I had a guy that said something about municipal bonds, and they were going to pay him 5%. Then the interest rates went down, and then he started buying at a premium.

I talked about this a couple weeks ago. Buying the bonds at a premium, literally he’s overpaying for the bonds.

Instead of paying $1000, he’s paying $1,010, $1,020 for the bonds, and it was going to mature at $1000.

So, you’ve got a built-in loss of $20 for each $1,000 bond. Then you’ve got an interest rate of 3%, and you’ve got an inflation rate, what? 6%.

So you’re losing 3%, and you’re losing another $20—2%—for however long it is before the bond matures. Before you know it, you’re really backwards and upside down in this whole thing.

So saying, “I think I’ve got to have something that can’t go down in value”—

Well, if you look at what can’t go down in value, what would that be that cannot go down in value?

If you answer a CD or a bond or something like that that pays a fixed—now, if you’re looking at a bond that pays a high interest rate, not only can it go down in value, it can lose everything because of interest rate risk and default risk.

So bonds, you’ve got different types of maturities, and you also have credit risk. What is the ability for this borrower to repay the loan?

Now, if it’s the federal government, pretty good ability to repay the loan because they can print money. But if you’re talking municipality, or you’re talking about a corporation, corporate bonds, there’s a good degree of possibility that they couldn’t repay the loan and that they will default.

That’s why they’re paying a higher interest rate many times.

Some municipalities, they’re fairly liquid. And they’re in municipalities or in cities or governments, local governments, that are fairly secure, so you don’t necessarily worry about that.

But there are some municipalities with one foot on a banana peel, as I like to say, and another in a bankruptcy court. Or just the idea that they could end up having a default because people move out of the area where the municipality is located, and then they don’t have any kind of tax base.

So that could be a huge problem.

Are Treasury Bills a Safer Investment?

Now, what is it—going back to the initial question—what is it that can’t go down in value, or is going to make sure that they’re going to pay their debt, come heck or high water?

It would be Treasury bills, right? Or CDs, we could say, but CDs could have some risks in that you have penalties for pulling out earlier, whatever.

So, let’s just go back to the Treasury bills where the government’s borrowing money for a short period of time. You look and say, “Okay. What’s the interest rate?”

Well, less than a half a percent. Okay, so basically we’re looking at something that—less than a half percent, inflation rates are pretty high. We look at that and say, well, what if we’re pulling off the interest on that every year?

So for every $1,000,000 you’ve got, you’re looking at it going, so how much income can I pull? Well, $5,000, if it’s earning a half percent.

And you go, “Well, wait a minute. How do you live off that?”

Well, the answer is you don’t, especially when prices are going up around you, and that is what’s called the risk-free rate. That’s why we call Treasury bills risk-free rate investments, because there is no risk.

Now, if we try to get a higher interest rate than that, now we have introduced risk to the process.

So, if I’m trying to live off of that, I’m going to—by definition—I’m going to have to draw down the principle.

There’s no way. I’m going to have to spend my money.

Diversification Is a Better Way

Now, when I’m looking at drawing down an income, what else can I do? Well, that’s where diversification comes in.

Now, diversification in what? Well, now we’re talking about stocks: small companies, large companies, value companies, growth companies, international, U.S., and then I mix bonds in that.

Now, what happens when I start to introduce those other asset categories? Now I can have short-term volatility.

And I can have the principle dipping below what I invested, simply because markets go down. Now, let’s go back to the year 2000, for example.

You had large U.S. stocks that went down 9%, and you had value stocks go up 3% as I recall. You’ll have small companies go up just a little bit, and then you have some areas of the market that actually—other areas that went down during that particular year.

Now, overall our portfolio was fairly flat, and if I were taking an income—flat to slightly negative, depending on how much in equities that you had. But if I were taking an income, I would’ve had to have dipped into the principle, so to speak, in order to take an income.

Let’s say if I were taking $40,000 or $50,000 off of a $1,000,000 portfolio. I would’ve had to have dipped into what I perceived as being the principle.

Now, I said “perceived.” Why did I use that word?

Because technically, in a year like that, where you have stocks that go down and fixed income hold their own right there, I would’ve been pulling more income from my fixed income, my bonds, during that particular year.

Now, because stocks went down, the overall portfolio would’ve gone down. Even if my bonds went up as, let’s say, the bonds spiked in value like they did in 2002.

You had a 13% or 16% increase in intermediate bonds. Intermediate bonds: where you’re borrowing money for a five-year period or the government’s borrowing money for five years, let’s say, somewhere in that neighborhood.

That would be intermediate bonds. Typically somewhere in that neighborhood.

But even if I pulled all the gain out of the bonds, still my stocks went down, so I would’ve seen my portfolio value go down. That’s like, “Whoa, wait a minute! That’s kind of scary!”

But think about it this way. If I were taking income from an investment portfolio that had some bonds and fixed income, and I tried to take more money from the bonds and fixed income during years like 2000, 2001, 2002—now that wouldn’t have necessarily been the way you did it because technically if you looked at 2001, small-company value stocks actually did quite well.

But I just want you to get the idea of, when you have weak markets, let’s say—weak stock markets—you take more income from bonds.

But if you look at what happened in 2003, you had small company—small-company stocks went up over 50% that year. Then the next year, another over 20% return, and then another 7%, another 19% return.

Ups and Downs in the Market Are Key to Meaningful Returns

If you’re thinking about it, if I’m taking money from my investment portfolio, and I’ve got stocks going up well more than the percentage that I’m taking from the portfolio, you can see how that would’ve helped me while I was taking an income to recover anything that it was under in prior years.

This is key because if I take an investment portfolio, let’s say, that is 60% stocks and 40% fixed income—

And if I follow a lot of the rules of investing that I talk about here, I’ve got large U.S. stocks— historically, rate of return going back to the 1920s, 10%. Small companies at 12%.

Value stocks at over 11–12%, and small value at 14%. And international—we have data on British stocks going back to the mid-1950s: 10% return.

Then small international stocks going back to 1970: 14% return. Long-term returns.

So you think about it, and I go, well, what if I just go and stick all my money in Treasury bills, what’s the return after inflation? 0.5%.

And you compare that to other market asset classes that you’re looking at 7%, 8%, 9%, 10% return after inflation, you go, “Well, how could I possibly take an income from an investment portfolio that’s all fixed income and hope that I could do anything?”

So what am I going to have to put up with? I’m going to have to put up with the ups and downs of the stock market because the only way to get those returns above inflation out there, really, historically, has been that.

Is Inflation Bad for Stocks?

Now, the question comes up, which is, well, what about if we have inflation, isn’t that going to be bad for stocks as well?

Well, there was actually an interesting article on that, and it was entitled, “Will Inflation Hurt Stock Returns? Not Necessarily,” was what it was entitled.

“Investors may wonder whether stock returns will suffer if inflation keeps rising. Here’s some good news: Inflation isn’t necessarily bad news for stocks.”

This is something I’ve been talking about a long time here on the show, so I thought this was good validation for what I’ve been talking about.

“A look at equity performance in the past three”—

And remember why I say that, because I say, what’s inflation? Prices going up.

Who’s raising prices? Companies.

What do you own when you own stocks? You own the entities raising prices.

So that’s the why behind it, so it makes sense. I own stocks, which is owning companies.

And what is inflation? Prices being raised by Walmart, and Kroger, and Walgreens, and Home Depot, and Tesla, or GM, whatever, Microsoft or Apple.

It’s prices being raised.

So they’re raising prices, and I own the companies, so I own the companies that are raising the prices.

So hopefully you get that idea.

Now it says, “A look at equity performance in the past three decades does not show any reliable connection between periods of high (or low) inflation and [U.S.] stock returns.”

So we would call that non-correlated.

“Since 1992, one-year returns on U.S. stocks have fluctuated widely. Yet weak returns occurred when inflation was low in some periods.”

So you can have low inflation and not much of anything going on in stocks, is basically—so it isn’t because of inflation that necessarily drives stocks down.

“Twenty-three of the past 30 years saw positive returns even after adjusting for the impact of inflation.”

So 23 of the past 30 years. Well, you often hear me say, two-thirds to three-quarters of years, markets go up, and just face it, that’s what they do.

Protect Your Portfolio With Stocks Plus Fixed Income

That is literally why, if we look back at history, and we go, okay, so stocks protect us from inflation.

Historically, they’ve had higher returns. Okay, I’m getting something.

What do I have to put up with? You have to put up with short-term volatility.

So how do you protect yourself from it? Fixed income, and the right type of fixed income.

So when people say to me, “I want something that can’t go down in value, and I can’t go dip into my principle,” there is no such thing.

You have to dip into principle if you take all your money and put it in Treasury bills or something that can’t fluctuate in value. You have to dip into principle to get the income.

And literally, your likelihood of running yourself into the ground is extremely high.

Whereas if you hold equities or stocks and fixed income in a portfolio, will you have years where the portfolio goes down? Yeah.

I mean, I can’t tell you that that won’t happen. Nobody can tell you that that won’t happen.

Matter of fact, I fully expect it will happen. But it doesn’t bother me, because I know that when you have recoveries, like I walked you through, when you have recoveries when the market goes up, it doesn’t go up.

If it goes down 10%, typically you’ll see it’ll go up 20%, 30%, 40% after, when the recovery occurs.

How Long Will It Take to Recover From Downturns?

If we go all the way back to the Great Depression—I love pointing it out in the Great Depression, because that was just such a nasty, nasty market downturn.

Matter of fact, I was showing somebody this week. We were having a conversation; it was on a Zoom call of all things.

So I had my chart behind me, and we were talking about this very topic and talking about market fluctuations.

And I like setting expectations because if you know to expect that there are going to be weird things that happen in the market, then it doesn’t wing you out when it happens. It doesn’t bother you.

But I said, “Imagine how it just … ” And I was really dramatic: “The Great Depression, an 80% decline in the stock market.”

She’s going, “Oh my goodness.”

I said—now, if you were diversified amongst, in many areas, it wasn’t as big of a decline, but—”Just an 80% decline in large U.S. stocks.”

She goes, “Oh my goodness.”

And I said, “Okay. But if you held on through 1933 and ‘34 and ‘35 and ‘36, you are back to even again. You are back to where you started from.”

So that tells you that if you had that big of a decline, I mean, what kind of an increase in value in your portfolio do you have to have to come back from that? The answer is a 400% rate of return.

So if I panicked, let’s say, and I got out of the market—I remember doing a video on this.

It was after one of the market downturns, and I was talking about if you panicked and actually stuck all your money in cash after the Great Depression, the downturn in the Great Depression, how long would it have taken you to have gotten back to where you started from?

I was comparing that to using stocks. How long did it take?

Because you got all the way back to even by the end of 1936. Then you had—we had gotten into World War II and went down a little bit and came back up, and never saw that level again.

But the point that I was making was how many years did it take if you had put your money in fixed income, like Treasury bills, based on the rate of return, historic rate of return of Treasury bills after inflation?

It was over 400 years. You just never got back.

Risk and Fluctuations Are Part of Investing

That’s just the point. As an investor, risk is part of the deal.

Risk, what is it by definition? It’s just fluctuations in value.

For me to have lost everything, that’s what most people think of when they think of risk: “I could lose everything.”

Well, for you to lose everything when you diversify across tens of thousands of companies, and all kinds of—you’d have to have global financial Armageddon.

Every company: Walmart, Walgreens, Home Depot, Microsoft, Apple, they would all have to go bankrupt. Their land would have to be worth nothing, no residual value to it whatsoever, for you to lose everything.

So the reality of it is, the likelihood of something like that happening—we’ve got bigger problems if it happens, that’s the reality of it.

This is the essence of investor coaching really, is really helping you understand how to measure risk, what it is, what the risks are in the investing process, and how to mitigate them to some extent.

That’s the idea.

So when we look at income, we can really get taken advantage of. And we look at, how can I get an income and have no risk whatsoever?

When we start asking questions like this, that’s when the investment industry people can take advantage. Not because they’re willfully trying to take advantage of you, but because that’s the way they’re trained.

That’s the way I was trained.

I remember years and years ago: “Oh, you don’t want to lose anything. What we’ll do is we’ll put you in this fixed-income investment, and you won’t have any volatility whatsoever.”

We didn’t really think about inflation. We didn’t really think about the fact that we would be—well, back in those days, interest rates were somewhat decent.

Now there’s nothing except products that promise that they might pay a decent rate of interest in the future sometime if the stars all align. But anyway.

So the bottom line is this: There is no such thing as a free lunch, and the better educated you are as an investor, and know what to expect, know how to measure risk, know what diversification really is, the better off you will be trying to navigate this thing called retirement.

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