Wednesday, January 11, 2012

My investment plan, pt. 2

As I noted in Part 1, I wrote down a detailed investment plan before quitting my job at age 55. Well, I've known a lot of people who retired early and ended up looking for work again remarkably soon.

Sometimes, that was because they were bored with retirement. (Honestly, I can't understand that at all. Retiring early was one of the best moves I've ever made, and I seem to be busier now than before I retired. But people are different.)

For most, though, it was because they'd ended up in financial difficulties - often enough, in just a year or two. And so they went back to work, but in jobs that paid a lot less than the one they'd just quit. I didn't want that to happen to me!

But I'm wary of sharing the details of my own investment plan, because I don't want to give you financial advice, even by implication. For one thing, I'm not qualified to give you such advice. And if you're in the habit of taking investment advice from your neighbor or some random guy on the internet,... well, good luck with that!

Besides, I wouldn't recommend my own plan to anyone else. I'm certain that no reputable financial adviser would recommend it to anyone! After five and a half years, I'm still convinced that it works for me. But my situation is not yours.

Let me just leave it at that. I'm a very private person, and although I'm sure I end up sharing far too many personal details in this blog, I'm not actually comfortable with that.

But let me just say that I'm not wealthy. I could only retire at all because my expenses are low. But I was looking at years without Social Security or Medicare (indeed, retiring early will drop my eventual Social Security payments drastically), and certainly no pension. So it was a pretty significant step to quit my job and decide to live on my investments.

Now, I didn't actually expect the worst economic collapse since the Great Depression. You have to expect bear markets, but frankly, the reality exceeded my worst projections. Given all that, I can't be too unhappy at the results. I'm just slightly ahead of where I was when I retired, but that's after paying all of my living expenses for almost six years. Therefore,... so far, so good.

My written goal on my financial plan was very simple: "To survive without depleting my savings." (Remember, I said that my plan was far simpler than yours would need to be.)  My expectation: "That I can live on my earnings while growing my financial assets (after inflation)."

What I needed to know first was the amount of money I would need for living expenses each year, on average. Well, I've kept my financial records on Quicken for many years (and I've avoided paying cash, wherever possible, so I could tell where my money went).

It was easy enough to average my expenditures over the previous decade, even adding a little extra for inflation, but I needed to look into it a bit deeper than that. For one thing, I could subtract from that the amount I was adding to my investments each month, and I could subtract most of the amount I paid on income taxes, too. (If I did better than expected, paying extra taxes would not be a problem!)

My health insurance costs would increase dramatically, though. And I had to expect occasional big expenditures on home repair and car purchases. I thought I was being very conservative, but I've actually been spending more than I expected. However, I wasn't too far off, I guess.

From Quicken, I knew my net worth, of course. My house isn't a big part of that, but it still needed to be subtracted from the equation. (I wasn't going to get a mortgage just to invest that amount in the stock market.) But I was left with a very rough idea of what percentage return I would need, on average, just to survive.

As you might imagine, it wasn't that simple. First, in order to survive for long, that percentage return needed to be after inflation. When you're working, you can usually count on your pay increasing every year, to at least cover inflation, So it's easy to overlook that. But once you were retired for ten or twenty years, you'd probably be shocked at how inflation adds up. (I'm shocked already at the increased cost of food and health insurance.)

And all these were just averages, too. This past year, I've had some major home expenses. With any luck, it will be a few years before something like that happens again, but I still had to pay them now. And that money is no longer available for investments.

The stock market, of course, is notoriously volatile. That was obvious even before the recent crash. Volatility isn't a problem, unless you need to sell before the market recovers again. And that could take years. On the other hand, if you avoid volatile investments, you'll be lucky to even match the inflation rate (very lucky, right now), let alone make something above that.

My point is that there's a lot to think about. And you cannot reliably predict the future. No one can. As I said, I don't want to tell you the details of my own solution (really, I'm not giving investment advice here), but I will say that it's mostly stock investments (in mutual funds, for reasons I noted previously), with a large emergency stash, so I don't have to sell when those investments are down.

Anyway, after I set out my requirements in that investment plan, and looked at the risks, I decided how I wanted to apportion my money - how much I needed to keep in cash, for immediate expenses; how much I needed for an emergency stash, and where I'd keep it; how much I needed in more conservative investments, in case even that emergency stash wasn't enough; and how much I could truly think of as entirely a long-term investment.

In my case, the vast majority of it was in the latter category. Well, it had to be that way. I really didn't have any choice, because you pretty well need to accept volatility in order to get a return that's above inflation. Again, that's just an average return, and it might be a very long-term average, too. It doesn't help much if the stock market recovers after you've already gone bankrupt.

On the other hand, if you keep too much in "safe" investments, you won't make anything. Indeed, you'll probably lose money, after inflation.

Younger people, working people, don't have to worry about this. (I know, they have other things to worry about.) If the market crashes, they'll just be buying stock at a much cheaper price. Indeed, for a young person with a secure job, a stock market crash might be the best thing to happen. (But note that "secure job" part again.) When the stock market drops, that's when you want to put more into it. (Unfortunately, that's just when it's the hardest to do.)

But if you don't have a job, you won't have that income to be buying cheap stock during crashes. And sorry, but I don't think that anyone can reliably predict the direction of the stock market. Some people do get lucky, true. If you have a roomful of monkeys throwing darts at stock listings, a few of them, just by the laws of statistics, are going to look like investing geniuses. But they probably won't do so well the next time they throw those darts!

On the other hand, it's not impossible to recognize the extremes of either irrational exuberance or panic. It's just likely to be very, very hard to act as a contrarian at such times. When everyone you know is talking about how much money they're making from tech stocks, can you avoid the temptation to jump in, yourself?

What if it continues for two or three years, with everyone but you making money? How will you feel then? As... someone said, the market can stay irrational for longer than you can stay solvent.

When the whole country is panicking and there seems to be no bottom to the stock market crash, can you decide that stocks are just too cheap to pass up? Even knowing that they'll likely get cheaper, because you have no idea where the bottom is, either? "Buy cheap and sell high" is a nice slogan, but investors usually do just the reverse.

There's a good reason for that. It's hard to be a contrarian. And contrarians are often wrong. In fact, they're almost always wrong, at least at first. So how long can you stand to be "wrong" before deciding that, yes, you really were wrong? As it turns out, most people are contrarians right up until the worst possible time to change their mind.

And no, I'm not going to tell you what an investment genius I am. I'm just as human as everyone else. When everyone else gets afraid, so do I. When everyone else is irrationally exuberant, I feel great about my investments, too. It feels good to make money and it feels bad to lose it. It doesn't make any difference how much of a contrarian you want to be, you'll still feel those emotions.

Sorry, I get carried away. This post has not gone where I expected it to go. I thought I'd write more about my actual plan - if not the details, then at least some of the general advice I gave myself (like "Diversify - but remain skeptical of the latest fad"). But those things look more like obvious platitudes, now.

I thought maybe I'd talk about different risks - volatility (or market risk), inflation, deflation, recession, stagflation, terrorism - and my predictions of what they'd mean to different kinds of investments. There are risks in everything. Even government-secured investments have a great deal of risk (inflation risk, in their case). If something looks risk-free, think again. You can't eliminate risk, but you can try to manage it.

But much of that gets into the details of my plan - how I planned to manage those risks, as much as possible. And the details are just what I don't want to give. Seriously, my investment plan won't work for you. It might not even work for me, not for long. I just don't know. But I do know that I'm not qualified to give advice.

Yeah, this probably wasn't what you expected. Heck, even I'm bored by it.  :)   But I think you might enjoy Part 3 a little more. I'm going to look back at what I wrote in my notes, every year or two, and see how things actually turned out during the past five and a half years.

Well, it's been a wild ride, so you might find it interesting. I hope so.

Note: Here's Part 3.

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