Jan 11, 2014

Stock Buy Break it Down - 4, Risk and Reward

Every household needs to save at least two million dollars for retirement.

              $2,000,000 / 25 years of retirement = $80,000 per year

Taxes and inflation lower the payout, so $80K is probably more like $45,000 by the time you pull it out.

If you plan to spend a lot in retirement on toys and Viagra or if you settle in a high cost of living spot like California, you'll need five+ million dollars for retirement.

Most of us won't live past 80, but we must assume so on the savings front so we don't run out.  If we croak early, any leftover dessert can go to spouse, charity and children.

Don't assume social security and pensions will pay out by the time we retire.  It's wise to take ownership of our investments and prepare for the worst.  Any SS or pension handouts will be icing.

Two million dollars is a bunch of money, but less painful if we start saving early, letting time and the compound effect do the dirty work.


Because we need so much $ saved up when we're old, I've got a different take on investment risk than you'll hear from anyone else.  Here it is:

The lowest risk investment plan is that which results in the highest payout by the time you retire.
The highest risk investment plan is that which results in the lowest payout by the time you retire.

The above is true because the worst possible investment screw-up is the savings pot is too small to support 20+ years of not working.

The optimal, least risky plan is that which results in the lowest amount of money you need to invest monthly to reach your retirement goal $

Based on the above, these two statements are true:

A "lower risk" investment strategy that's mostly made up of "safe" securities like bonds and low yield mutual funds is actually highly risky, because it likely won't build enough money to support retirement.

A "higher risk" investment strategy that's mostly made up of aggressive securities like growth, international and small cap' stocks is actually lower risk, because it likely will build enough money to support retirement.

As we get closer to retirement, we want to move money out of volatile stocks and into more stable, lower return bonds and the like.  If we have more than 10 years until retirement, it's wise to invest aggressively for the highest possible payout.

Here are two examples of high risk investment plans.  Risky because they end with not having enough money at retirement:

Bad Idea A)  Invest mostly in low yield bonds and "safe" mutual funds that pay out a few percent points per year.
Bad Idea B)  Invest mostly in penny stocks of sketchy companies that are unlisted and don't trade on major exchanges like NYSE or NASDAQ.  Known as OTC pink sheet stocks, you can read more here.

Bad Idea A ends with too low of a payout.  You'd need to chuck huge amounts of money into your investment funds each month to reach a $2M goal at retirement.

Bad Idea B ends ugly.  Many corporations with pink sheet stocks end up bankrupt, meaning you may end up with very little retirement money.

Bad Idea A is too conservative.
Bad Idea B is too stupid.

Both are risky.

The least risky strategy is to invest as aggressively as possible and as young as possible, without hitting the Bad Idea B stupid zone.  Slowly transition to less aggressive investments as you approach 5 or 10 years till retirement.

Let's run some numbers to prove that a more aggressive investing approach is less risky than a timid approach.  Remember that my definition of risky is having too little money saved up by the time we retire.

How much money do you need to save each month if you want to retire with $2 million?  I'll go with 40 years of savings (age 25 - 65), contributing monthly, compounded annually.

If you invest too conservatively and see a 6% annual return, you'll need to save $1,080 per month.



If you invest aggressively and see a 11% annual return, you'll only need to save $287 per month.


I'd rather save $287 per month than $1,080.

What do you think:  is an aggressive, higher return plan less risky than a timid approach that offers a low return and requires you to save more monthly?

Off to El Rodeo now for dinner.   Next time we'll talk more about investment vehicles.

-Beard



3 comments:

  1. I look forward to reading your blog when I get a chance. Looks very interesting. Mine is about becoming debt-free. (Last August)

    ReplyDelete
  2. Anonymous1/15/2014

    Beard- love the financial blogs!! keep it up!

    ReplyDelete
  3. This is great information. Really, I am so impressed with your approach.Thanks for posting this.
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Thanks for the note, check back for my response!