Tuesday, May 16, 2017

Live Off the Interest - Revisited

Living off the interest isn't just a fantasy, it is a dangerous fantasy.

I talked before about living off the interest and how for most of us, it is just a fantasy.   Even if you have a million dollars in savings, at ordinary interest rates, it hardly yields enough to live comfortably on, unless you go for high-risk, high-return investments, which could bankrupt you over time.  Yet it is a fantasy that many middle-class and lower-class people have.  "I'll make enough money so I can just live off the interest and never touch the principal!" they say.  Of course, these sorts of folks cannot ever afford to save up the heroic amount of money to do this.

Two recent articles about retirement and spending your money highlight one aspect of retirement that is somewhat stress-inducing.   How much of your savings should you spend every year?    This question becomes more acute as a new generation, such as myself, lurches toward retirement with only savings to live on and no pension.    Yes, there is Social Security, but Republicans keep talking about a "needs test" or cutting benefits - hardly the reason to go out and celebrate and spend some of that 401(k) money, is it?

The problem is twofold.   First, if you cut back on spending for fear of losing your nest-egg, you may end up with a very frugal and shitty retirement.   You are supposed to spend this money, over time, until you die broke.  In fact,  if you keep the money, and go into assisted living (a very likely scenario) then you'll have to spend it all on assisted living before Medicaid kicks in.

The second problem is more insidious - some seniors, not wanting to touch their "nest-egg" will put their money into high-yield stocks and bonds, so as to increase their income, but at the same time, put their nest-egg at risk.

By the way, where did this "nest-egg" term come from?   An egg is something you hatch into a chick and then nurture until it flies away once it is old enough to leave the nest.   It isn't something you keep around forever, is it?

Once again, I digress.  Or maybe not.   Maybe the analogy to nest egg is apt.   In real life, birds build nests, lay eggs, nurture them and then they hatch, grow, and move on.   A nest egg is not forever.

And similarly, in retirement, it is OK to spend the interest (and dividends and capital gains) but it is also OK to spend some of your principal, in an orderly manner.   You are not going to live forever, so that changes the entire prospect of how to spend your money.

"But suppose I outlive my money?" the seniors cry.  And it is not hard to understand why they say this, as the financial media hypes this story a lot.   But most seniors who "outlive their money" didn't necessarily outlive it, so much as they didn't save much to begin with or squandered it on silly things like half-million-dollar motorhomes or boats in retirement.

Due to the "Trump Bump" my savings haven't seen much of a drop lately, even though I am selling off stocks, cashing in the money and spending it.   Now, some of this money is indeed dividends, interest, and capital gains.   And I still have a small and dwindling income stream as my law career coasts to a halt.   But the bulk of my "income" today is savings - which is why my tax bill is nearly non-existent.  When we start tapping the 401(k) and Social Security, our tax bill ironically may go up.

So I take money from a savings account and spend it.   A month later, my net worth (according to Merrill) is the same if not higher, thanks to the run-up in the stock market.    To some extent, this is a good thing, as I am an early retiree, and I do need to make this money last longer.   But I do realize that the "Trump Bump" is based in part on illusion and not realistic thinking.   Whether the economy can grow at 4-5% a year as the administration predicts, remains to be seen.   And from my perspective, this could be a frightening prospect, as the corresponding inflation could reduce the spending power of the money I have.

That is another aspect of "living off the interest" that few talk about.   Sure, the stock market goes up, over time, historically.   But that doesn't necessarily mean if you put a dollar in the stock market, it will be worth more over time.   Inflation can wipe out gains in short order, much as they did in the late 1970's.   And with talk of restricting imports and imported labor, prices for goods in the US could skyrocket.  Already we are seeing "help wanted" signs wherever we go, which means wages will go up, and prices as well.   It is hard to tell, to be sure, but it seems like everything is just getting a little more expensive these days.   A cup of coffee at the club hotel cafe was $2.75 - outrageous enough.  A week later it is $3.25.   All the more reason to make coffee at home, eh?

The danger of the "live off the interest" mentality for seniors is that you may desire to "beat the market" in order to be able to generate perpetual income.  If you only have $500,000 saved in the bank, you may be tempted to put it into stocks generating a 10% rate of return in order to get an income of $50,000 a year.   The problem is, such stocks are volatile, at a time in your life when you cannot afford to recover from negative volatility.   Moreover, to get such a rate of return, you have to put nearly everything into high-yield investments.  Thus, you cannot diversify your portfolio by putting some into lower-yield, low-risk investment.

And a lot of people in retirement live this way - I've met them.   They lived on the knife's edge when working - leveraging themselves in debt to buy a fancy house and putting all of their retirement 401(k) savings into risky high-yield investments.   When the economy crashed in 2008, the value of their house went down and their 401(k) went down.   And being "paycheck-to-paycheck" many lost their shirts - some their houses and 401(k) as well, as they tried to hang on to a house they could not afford.

So, with reduced savings for retirement, they are back on the knife-edge again, trying to use high-yield investments to generate higher incomes to retire on.  The problem is, if the market goes down (and it will - it always does, just as it always recovers) their income will plummet and their savings will as well.   But of course, what else could they do in the situation they are in?  If you enter retirement with less money than you need, your options are not many.

On the other hand, this idea that "rich seniors " are  "hoarding" money is both right and wrong.   Yes, some oldsters don't want to touch their principal, based on folklore and things they heard from their parents (my Mother used to say this, even though no one in our family, going back for generations, ever had enough money to "live off the interest").

Others I have talked to want to "leave an inheritance for the kids" which is another piece of folklore that many families have.  My Dad always groused he never got an inheritance from his Dad, other than an "old used Buick" and that somehow that was unfair.   Of course, my Mother did try to leave me an inheritance in the form of a trust, and my Dad saw no problem in tapping into that for personal and frivolous reasons.  What is left of it, I may or may not get, depending upon how conniving my brother the executor wants to be and whether I want to bother to sue him.  Never count on an inheritance!

I find that ironic that while my Dad groused about the "raw deal" he got from his Father, the only real inheritance he left to me was the remnants of an under-funded IRA which amounted to about $4000 - not enough to buy a secondhand Buick.   The difference is, of course, that I am not browned off about it, since I never expected to get anything out of him, knowing his spendthrift habits.  I am still browned off about him euthanizing our cats, as well as his telling everyone that he "paid my way through law school" when in fact he paid nothing at all.   And there are a few other things as well.  He was not a nice person.  Charming, yes.  Most sociopaths are.  But I digress.

 Hell is full of Dads...

This "leaving an inheritance for the kids" nonsense is how seniors get conned into buying burial insurance, which is a bad bargain.   Too late in life, they want to be big-shots with an "estate" that the children will fight over.   And yea, that is sick, but there are kids who suck-up to a parent or grandparent or other relative, in order to get mentioned in the will.   And their are parents who will intimate that large sums are waiting to be inherited, if it gets the kids to visit more often.

Sadly, I have seen this firsthand, when a relative believed they would inherit enough money to retire on from a rich Aunt.   Sadly, while the Aunt did leave an estate of nearly one million dollars, it was divided by 11 relatives, leaving not nearly enough to retire on, but enough to buy a nice Acura.   Needless to say, the relative was quite pissed-off by this, as she had failed to fund her 401(k) on the premise that the "rich aunt" would take care of her.    Really bad move!

Planning for retirement is difficult, and it takes a lifetime to do.   But once you get there, the fun just starts, as the planning is just beginning.   You do have to figure out how much money you should be spending, how much you can spend, and how long it will last.   And there are so many variables in the equation.   Will inflation go up?  Will there be a recession?  How long will I live?  Will my health get worse?   And the answers are, Likely, Probably, not as long as you think, and Oh-boy-YES.

So work out a plan to unwind all of this - to spend in an orderly fashion and enjoy the money while you can.  Travel while you are ambulatory - you can always go on those low-cost senior bus tours when you are less able.   Spend a little, but don't blow huge chunks of dough on stupid stuff.

And don't expect to "live off the interest" unless you are truly wealthy and have millions in the bank.   And even then, ask yourself why you'd want to do this.   To leave money to your kids?   Quite frankly, all that does is ruin them.   Just spend it.   If you do this retirement thing right, you'll spend your last penny when you take your last breath!

* * *

A reader writes:
Obviously, you have never kept chickens! A “nest egg” is an egg that is not collected, but instead, left where the human poultry-keepers want the hen to lay more eggs. The nest eggs keep the hens returning to the same spot to add one more egg. Nest eggs nowadays are usually fake (Golf balls are often used.) but traditionally they were just eggs that one delayed collecting for a few days. So, a “nest egg” means a consumable good that one defers consuming (and, like interest-earning money in the bank, can help one accumulate more).
BTW, a number of everyday terms come from poultry-keeping. A low-quality item (like stale bread given to chickens) is “for the birds”. A “brooding” person is inactive and withdrawn from regular activities, like a hen sitting on eggs to hatch. “Hackles” are a chicken’s neck feathers, and a chicken with its "hackles up” is an angry one (as is a human).
So, in other words, a "nest egg" is a useless object that never amounts to anything.  How odd!