Friday, March 15, 2013

Being prepared for the worst

It's nasty out there. I know a fellow with a great education, a fine work history and a lifestyle that is the envy of almost all. When the economy crashed in 2008-2009, he lost his job. Despite all he had going for him, he has failed to completely recover from the personal setback of four years ago. The sector in which he has expertise has yet to recover.

Now, a financial sinkhole has opened under his wife. After more than a dozen years at a fine company with a fine job, the company has been sold and she is finding her job threatened.

This couple lives in the States. When a couple loses both good jobs that were the financial underpinnings of their lives, they lose a lot more than Canadians. Here, I am thinking of the health care ramifications. For the first time in many, many years, this couple may soon find they are without health insurance. An unforeseen major health emergency could bankrupt these two. They are frightened.

There are some lessons here. One: Life isn't fair. This a truism that threatens all of us. We can be blindsided at any time. And Two: We must try, as best we can, to be prepared for the unforeseen.

I'm a big believer in budgets and spreadsheets. This doesn't mean you don't spend money, but it means you know where you spend your money. When my wife left her job as a manager some years ago, I looked at our budget. I found stuff to trim. It hurt but we survived.

Then I lost my job. A career approaching four decades came to an end. I jettisoned stuff, modified my life and my lifestyle and I pulled in our financial horns. It hurt but we are surviving.

The truth is, it hurt more when my wife stopped bringing in the big bucks than when I lost my income. That first disaster was a wake-up call. We visited banks and talked to financial advisers. Although I had dabbled in the market all my life and my wife had worked in the market early in her career, we were not using the market to full advantage. Talking with the banks and the advisers made us aware that we should open our own self-directed portfolios.

Between the time my wife left her job and I took early retirement, we took control of our financial lives. We began experimenting with various financial approaches and using our portfolios as our test bed. I started a spreadsheet to track our income and our expenses.

The advantages of dividend paying stocks quickly became apparent. We began replacing our missing income with funds generated by our retirement savings. When the Christmas layoff struck the newspaper, I turned to my spreadsheet and confirmed I could live on the reduced pension being offered. I took a buyout, stuck the money in the market and never looked back.

I believe everyone should track their income and expenses with a fine-tuned spreadsheet. It is easy and not at all time consuming but it is eye-opening. You might find yourself very surprised to learn where your financial life leaks money.

The couple I spoke of earlier have been dipping into the husband's retirement funds in order to live. I wonder about this. I think about how I remove an amount equal to six percent of my retirement savings at retirement each year without ever touching the underlying investments.

If the couple now facing their own financial Armageddon had invested all their retirement money in dividend paying stocks back in 2008/2009, they might have an annual income available to them of about $32,250 today. (This is based on them having about $600 thousand in retirement savings at that time and only removing dividend payments. This also takes into account a ten percent penalty imposed by the U.S. government on funds removed early from a retirement plan.)

If they have $500 thousand still in their plans, they could gamble today on some investments that return better than six percent. For instance, REM (iShares FTSE NAReit Mortgage Plus Capped Index Fund) is paying 10.95% today. Investments like this could deliver better than $49,000 income annually -- after expenses.

I have a little REM in my portfolio and I wish I had more. I got in when it was maybe half the price.

I know this couple has a financial adviser. With a portfolio of this size, his/her payment should not be equal to more than one percent of the value of the portfolio. If this person is good, it should be possible for their retirement funds to generate good cash flow and maybe keep the wolf away from their door. (I cannot say for sure as I don't know all that much about their expenses but they don't have kids.)

I realize this couple would be taking a big chance by restricting themselves to high dividend paying investments. In a downturn a lot of the value in their portfolio could disappear quickly. On the other hand, if they simply start withdrawing funds in order to keep their books balanced, they could completely deplete their retirement savings in just a few short years.

I don't know what they will decide to do. One or the other may soon get a new job. They may get a break, a reprieve, a stroke of luck. If they do, I hope they take advantage of the breather and take control of their financial lives, open a couple of self-directed portfolios and track their income/expenses with a spreadsheet.

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