Excess Risk Isn’t Your Only Option

Okay, your 401(k) has become a 201(k) and you’ve lost a ton of money in the market. You actually believe those researchers who claim the sting of a financial loss is much more intense than the smug satisfaction of a large gain. Yeah, gains bring relief, but losses bring on sleepless nights and worry. If you’re in your 40′s, 50′s or 60′s, you’re probably more motivated than ever to instruct your financial advisor to take a little more risk so your portfolio can benefit from a little more reward.

Risk vs. Reward

But too much risk is probably what got you in trouble in the first place, even if that risk wasn’t fully recognized by you, your advisor, or the markets. The most important path you can follow at this point isn’t necessarily to pump up your portfolio with extra risk, but to bring down the cost of your anticipated retirement lifestyle through smart, thrifty, and frugal living.

Your ability to retire in the future will be dependent on one thing: cash flow. If you can reduce your need for cash in retirement, your options really open up.

How to reduce the need for retirement cash

1. Pay off debt. Nothing sucks the wind from your portfolio’s sails quite like debt payments. If you want to retire in the next 20 years or so, learning to live on less by avoiding debt will be a key factor both then and now.

2. Pay off your mortgage. Personally, I plan to completely disregard the naysayers who claim that the tax deduction is a good reason to keep a mortgage. Why pay $10,000 in interest just to get $2,800 back on my taxes? Usually their calculations include some huge return in the stock market as proof you should invest instead of pay off the mortgage. We all know what can happen when you “count” on those type of returns. And there’s a better than even chance that I’m going to invest in safer, less risky investments when I’m retired.

3. Consider a side job. Consulting, blogging, babysitting, freelance writing, or anything that will make extra money will reduce your need for the interest from your retirement assets.

How much to draw?

Experts have traditionally recommended retirees draw from their portfolio at four percent per year, but given the dismal returns on guaranteed asset classes (CD’s, annuities, etc), that number should probably be closer to three percent … at least for the next few years anyway. Using a three percent number:

Every $1 in monthly after tax retirement income you wish to have means your portfolio requires $300 to sustain it (assuming three percent draw and a 28 percent tax bite).

Now, this is a very conservative model. Try the numbers out yourself: $300 at a 6 percent interest rate less a 28 percent tax bite divided by 12. It equals $1.08. I’m padding my calculations with that extra 8 cents to allow for the unexpected.

What is “the unexpected?”

  • Unexpected medical expenses
  • Unexpected drops in the value of your portfolio
  • Unexpected needs of children or grandchildren
  • Unexpected GAINS in your portfolio – just don’t spend it all in one place!

Retirement isn’t out of reach

Decide how much you’ll need

Think you’ll need $4,000 after taxes per month to live your perfect retirement? Using those numbers, you’ll need a $1.2 million portfolio. But before you get depressed and think, “In that case, I’ll NEVER be able to retire,” consider this, for every $1,000 in after tax monthly income you can generate with your side job, your portfolio can be $300,000 smaller. Generate a monthly income of $2,000 though your little side enterprise and you need to save half as much as you originally thought.

Decide what you’ll do

What will you do in retirement? If you plan to kick back and sit on your rocker, you obviously won’t need much, but if you’re planning an active retirement, you’ll need either interest bearing assets or some other form of cash flow.

Decide to live the frugal lifestyle now … and then

Living frugally now makes sense because it gives you the opportunity to save money and essentially send it to your future self in retirement. Living frugally in retirement (and maybe having a side income) makes sense because it reduces the amount you have to have in interest bearing assets.

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