Safe Asset Returns

By Brad Thomason, CPA

 

Over the years we have noticed a strong tendency when it comes to investors.  As a rule, those who have already made a lot of money approach investing very differently from those who are still trying to build their balances to a certain level.  Which makes a lot of sense, if you think about it.

It’s been said that fear is what drives all financial decisions.  But it turns out fear in the financial realm comes in two forms.  One is the fear of losing something you already have.  The second is the fear of missing out on something that could be good.

Far and away, the fear of loss is the one you see most often with those who have significant amounts of capital, and this holds whether the investor is an individual, a corporation or an institution.  Those who have worry more about losing than they do about missing out on getting more.

However, just because these investors do not want to lose their winnings, that doesn’t mean they are content to accept the kind of small yields that are the product of the current low rate environment.  The whole reason for having capital is for the productive capacity that it represents, and the lower the rates go, the greater the urge to ignore the risk concern in search of higher yields.  So although the preferences are usually consistent with the principle, the actions chosen are sometimes less consistent.  Even when they are, it’s still a source of stress.

In consultations with individuals who come to us for Retirement Income planning we usually suggest the notion that those who have saved enough to fund the life they want in retirement should do what they can to get as much of their capital out of harm’s way as possible.  Everyone is enamored with the idea of making more money.  But here’s the thing: those who have saved enough to fund their lifestyle, have sort of already won the race that everyone is trying to win by saving for retirement in the first place.  If you are already in a position to fund your lifestyle, do you really want to gamble your win to achieve a surplus that you don’t really need in the first place?

Now, it is fair to point out that the only way you can know if you (probably) have enough to cover all the bases is to do a pretty in-depth analysis in which you compare your resources to your expectations, and plot out the conversion of those resources back into a stream of income over a many-year period of time (which is the heart of the Retirement Income planning work we do for our clients).  Even then, unexpected things can happen at some future point, so a bit of margin for error is a good thing.

But to simplify the point, if you think you need $12-$15 and you have $25, how much sense does it make to risk the $25 just to try to turn it into $50?  You’ve won.  Get your capital out of harm’s way and go live the life you’ve been working to build.  That’s our advice.

To help our clients understand whether or not they have their capital in places that are capable of generating “safe” returns, we ask them to apply a simple 3-question test.  Ideally, you would want the answer to all three of the following questions to be “yes:”

1.        Is the expected return going to be high enough to meet or beat the long-term rate of inflation?  Because if not, there could be a net loss of purchasing power, which would have the effect of accelerating the draw down rate and potentially leading to depletion of the capital.

2.       Is the return coming from an asset that is not going to lose value – even if temporarily – due to market fluctuations?  Because even if the decline eventually rights itself, you still lose time that was supposed to be productive; and to the extent you have to sell into the decline, the decline becomes permanent for you.

3.       Is the return coming from something that is actively producing today?  Did you deploy capital for something that will/may provide a return at some point in the future, or is it something that started producing a return right away?  Right away is a good thing.

A ‘yes’ answer to all three of these points to the probability that the winnings are relatively secure.  If not, some reallocation may be in order.

Those who already have substantial resources might benefit from applying this test to their own holdings.  Especially if you think you’re “covered” this might be a good way to identify places where you are exposed to risks that could change the situation.  Most people I talk to tell me it was arduous enough earning their life savings the first time: they certainly don’t want to have to do it again.  If you feel the same way, have a look at how your holdings stack up and adjust accordingly.

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