The Stock Series here is designed to slice thru the Gordian Knot of investing. To debunk the idea that investing is too complex for mere mortals and to dispel the fear surrounding it and our financial security.

Routinely, I hear from people who lament

• “I’m 32. If only I’d discovered your blog when I was 22.”
• “I’m 42. If only I’d discovered your blog when I was 32.”
• “I’m 52. If only I’d discovered your blog when I was 42.”
• “I’m 62. If only I’d discovered your blog when I was 52.”

Certainly the earlier you start, the better. The magic of compounding takes time to blossom. But is also amazing what can be accomplished with focused effort in only five or ten years.

That said, financial independence is every bit as much about controlling your needs as it is about accumulating assets. If you can live on $20,000 per year, having $1,000,000 makes you very rich indeed. Using the 4% rule, your needs are only half of the $40,000 your investments could provide. If you need $80,000 you are in serious trouble.

Most of the scary scenarios in the major media are centered around the idea that people have no flexibility in their spending. If that’s true for you, you have a bigger hill to climb. You are engaging only one half of our *accumulating assets/controlling needs* package.

In today’s Case Study, we are going to visit with Arnold, a 65-year-old man unemployed for the last 10 months. He is concerned about finding a job to meet his expenses.

After a lifetime of work, he has $73,000 to his name. He attributes this to having “…squandered money on cars, travel, eating out, girlfriends, clothes, motorcycles, businesses, high interest credit card debts etc. without giving much consideration to the financial consequences of my actions.”

He implores, “…please, younger people, don’t make the same mistake as I did…” in living the lavish lifestyle now gone.

Given my emphasis on the importance of accumulating F-You Money, you might expect this Case Study to be a cautionary tale. Certainly it would be in the major media: Another unfortunate who fell through the cracks.

But this discounts the “controlling needs” side of our equation. As I say at the end of this post:

“True financial security, and enjoying the full potential of your wealth, can only be found in this flexibility.”

Clearly, had he lived a bit less large and invested according to the principles we discuss here, he’d be better able to continue his former lifestyle. But I think there is a bigger and more important lesson to be learned:

The Power of Flexibility

Arnold writes…

Jim,

I’m so pleased I found your blog. Thank you for the wonderful service you provide to so many people all over the world and your excellent advice!

I hope you don’t mind guiding me as well.

I am 65 years of age, in an informal domestic partnership relationship with a lovely lady, and recently “semi-retired”. I have $40,000 sitting in a zero interest money market account at Bank of America and two work-related 401(k) plans worth about $18,000. I also have about $15,000 in cash stored in a safe.

At this time, I have no income and for the past 10 months, have been drawing money from my savings to live. Fortunately, I am pursuing a frugal lifestyle and my living expenses are at about $800 per month – I can possibly trim it down another hundred or two a month. I will soon have to start working again part time to fund my living expenses.

Needless to say, I have so many regrets that I did not save and invest in my youth and during my adult working life and plan for my retirement. I squandered money on cars, travel, eating out, girlfriends, clothes, motorcycles, businesses, high interest credit card debts etc. without giving much consideration to the financial consequences of my actions.

The end result of these actions is that I now will have to rely on social security to sustain me for the remainder of my life. Who knows what will happen or where I will land up when I become too old to take care of myself.

Jim, would you mind if I interjected a brief word of caution at this stage to the younger people reading your blog – please, younger people, don’t make the same mistake as I did…don’t…

I am not yet receiving social security -I am trying to delay claiming it for another 5 years until I’m 70, at which time my payout will be the highest, about $1700 – $1800 a month.

The money I have in the bank, the two 401(k)s and the cash in the safe is ALL I have. During the recent recession, I turned a blind eye to the concept of investing any money into mutual funds or stocks, as I had a fear of losing it all, as many others did.

Truthfully, I really didn’t understand investing, the stock market and mutual funds – I still don’t, but I’m doing a bit better now and am learning more and more each day, especially from your blog.

I am fully aware that my money in the bank is losing at least 3% of it’s value every year as a result of inflation whilst at the same time, I am deriving no income from it whatsoever.

I have read your posts in which you strongly recommend to people that they invest their funds into Vanguard VTSAX and you are not the only person making this suggestion.

In an ideal world, and I emphasize IDEAL, I would like to invest the $40,000 into a fund that will generate an income of $800 per month to cover my income for the next 5 years till I’m 70, without any depletion of the principal. I would then turn down the heat so to speak, to a safer allocation of funds at percentages that would allow me to sleep at night….That would be the ideal, but I presume it’s not going to happen in the present financial climate and that I’m going to have to work part time to supplement my income – like it or not- or alternatively claim social security sooner.

After all of that, my questions are:

Is your recommendation to invest into Vanguard VTSAX geared more towards younger folks who still have years of investing time ahead of them, or does it apply equally to someone such as myself who has already reached retirement age?

If it applies to me, could you please suggest whether I should invest the full $40,000 into Vanguard VTSAX?

Alternatively, do you have another suggestion as to an investment into another kind of Vanguard fund that will produce a better monthly dividend?

Thank you very much in advance and I will look forward to your reply!

Arnold

My reply:

Welcome Arnold…

…and thanks for the kind words.

Instead of directly answering your questions, let me give you three paths to consider. But before we get into that, let’s take stock of your situation.

We’ll get the bad news out of the way first:

There is no investment that can reliably return $800 a month ($9600 per year/24%) on $40,000. If we use the 4% withdrawal rule, generating $9600 a year would take $240,000.

This rule comes from an analysis of the Trinity Study and has become a popular benchmark for what can be considered a safe withdrawal rate. That is, a rate that allows for a portfolio to survive at least 30 years of inflation adjusted withdrawals.

That said, here’s the good news:

• You only need $800 a month and we can make that income happen pretty easily.
• You indicate that you could trim another $100-$200 from that, indicating some very serious flexibility.
• Flexibility in spending is at least as important as assets on hand. I salute you!
• You have $73,000 in investable assets: $40,000 in the money market, $18,000 in your old 401(k) and $15,000 in cash.
• At age 65 you are only one year away from your full retirement age of 66.
• If your Social Security benefit will be $1700 at age 70, it will be about 75% of that at age 66: ~$1275 per month.
• The break even for delaying Social Security until age 70 is ~83 years old. Unless you are pretty sure you’ll live past 83, taking it at 66 might be the better choice. Of course if you plan to marry your lady and your benefit would be greater than hers, she could take it over upon your death. That would make waiting on your Social Security an advantage for her.

With those tools in hand, we have three very interesting options.

Path 1: Draw on your savings and delay Social Security until age 70.

Roll your $73,000 into the Vanguard Balanced Index Fund, VBIAX. This is a balanced fund that holds 60% stocks/40% bonds, has a low ER of .09% and a dividend of 1.87%. It is less volatile than VTSAX (which holds 100% in stocks), and it will offer more growth potential than the cash you currently hold, giving you the the chance to keep pace with inflation.

Once it is there, instruct Vanguard to sell enough shares each month to transfer $800 to your bank account for your spending needs. I’d also have them send the dividend to your bank. At $73,000 x 1.87% that’s $1365 a year, paid out quarterly. I’d use this for extra “free” spending. (If you call Vanguard they will walk you thru getting this all set up.)

Looking at the math, we can see that drawing down $800 a month, $73,000 will last for 91 months or 7 1/2 years. (73,000/800=91)

Of course, the market will fluctuate over that time. If it moves in your favor, your money will last even longer. If it moves against you, your money should still last thru the five years until you reach age 70.

If it’s a disaster, you’d just have to go on SS a bit earlier. As we’ve seen, this would mean monthly checks ranging from ~$1275 to ~$1700-1800 at 70. Since you only need $800, you’d be golden even then.

Once you reach age 70 and start taking Social Security, you’ll  no longer need to draw on your VBIAX fund. You can just leave it to grow or continue to spend the money, but now as extra. It depends on whether you want to leave money to any heirs. If you do, you might also consider switching to the more aggressive 100% stock VTSAX at that point for better growth potential.

Path 2: Take Social Security starting at age 66.

As we calculated above, at age 66 your benefit should be ~$1275, very comfortably over your needed $800. Taking Social Security at age 66, you can either enjoy an expanded lifestyle with the extra $475 or invest it.

Your $73,000 you can invest in VBIAX and either let it grow, or draw it down as above to have still more to spend. This would give you a monthly income of $2075. ($800 + $1275 = $2075)

If you plan to leave it untouched for your heirs, you might consider the more aggressive VTSAX for more growth.

Please understand that both VBIAX and VTSAX will be volatile. You have to be prepared to ignore the inevitable periodic market plunges and stay the course for either of these plans to work. If you are used to holding cash this can be very unsettling.

If it is too unsettling, consider…

Path 3: Keep your money in cash, but otherwise implement Plans 1 or 2.

In the Path 3/1 scenario you’d skip investing in VBIAX and continue to hold your cash. Then you’d draw down on it at $800 a month. As we’ve seen, the money would last 91 months/7.5 years. This takes you comfortably to age 70 and the highest Social Security payout.

In the Path 3/2 scenario you’d start drawing your Social Security at age 66 and just hold the cash as you have been doing.

Of course, as you observed, holding cash means watching it erode at ~3% a year to inflation and giving up the chance for growth. For this reason, Path 3 is my least favorite.

Regardless of which path you choose, the truth is you are in excellent shape due to your modest needs of $800 a month, coming Social Security and $73,000.

Hope this helps, and enjoy your journey!

PS: This is a post you might enjoy — What it looks like when everything financial goes wrong

Addendum 1: This post is an expansion of my original reply to Arnold in the comments. If you are curious, you can read that conversation here.

 

Meanwhile and unrelated, recently…

Podcast:  

I was interviewed for the Create My Independence Podcast: F-you Money, Stepping Away, Fear and Investing. It was fun to do and I hope you find it fun to listen to.

And, if that’s not enough, check out my As Seen On… page.

New Book:  

My pal Matt Becker of Mom & Dad Money just put out his new book: The New Parents’ Guide to Financial Independence

If his name and website sound familiar to you, it might be because I have had the occasion to link to some of his past posts to amplify a point in one of mine or to introduce concepts I thought valuable to the readers here.

If you want to read all about it, just click on the first link. If you just want to cut to the chase and order it, click on the second. It’s worth your time.