In case you haven’t noticed, the world’s financial markets are in a state of total chaos . Normally avoiding financial topics, I’m compelled to post some thoughts and comments. For those unfamiliar with the jury-rigged world of investing, let me share a few basic concepts. First comes the disclaimer. Spending 31 years in the financial services industry, I’m not a licensed professional and you should never base any financial decisions on anything I write. Having said that, I did toil away in administrative and support roles, working mostly on the investment advisory side of the business. Known as “the buy side“, these are firms that manage assets for institutions, pension plans, and high net worth people. They buy and sell securities from brokerage firms and large banks known as “the sell side“.
Having worked side by side with many portfolio managers, I’ve always kept my eyes and ears open and learned enough to call myself a “self-directed investor“. This means we avoid paying exorbitant fees to advisers and instead, we use discount brokerage firms and manage our own assets. Intimidated by investing, many people avoid the topic and with no mandatory financial education requirements in our schools, it’s no surprise. Not really as complicated as you’d think, anyone can put together a well diversified investment portfolio designed to either be aggressive, moderate or conservative, depending on one’s risk tolerance. Through mostly no-transaction fee low-cost mutual funds, a few ETF’s and the occasional growth stock, we’ve earned about a 7.5% total return since the mid 90’s and no financial adviser can do better without taking on an extraordinary amount of risk.
Understanding the first rule is key to anyone thinking of retiring early and counting on the financial markets to fund your retirement:
The world’s financial markets are intentionally rigged against you. Run by a surprisingly small group of elites and with the world’s politicians and central banks, they exist only for the benefit of keeping the power and wealth in the world in the hands of a very small group of individuals. They are NOT there for average investors to make money and they’re certainly not designed to help you retire early. Period. End of story.
Fortunately, this doesn’t mean you should avoid the stock market. In fact, the only way to get ahead in a world driven by consumer debt is to be invested in the market. Anyone waiting for the return of “normal interest rates” on fixed deposits and other bank savings accounts products is in for a rude awakening. Interest rates are permanently lowered for the rest of our lifetime, banks no longer make money taking deposits and the expression “too big to fail” basically means world governments and central banks will never let the capital markets run themselves. In a nutshell, the world is now paying the piper for 40 years of financial government mismanagement, poor monetary policy and a convoluted belief that issuing debt is a never ending piggy bank that keeps churning out easy cash and financial profits for centuries to come.
Back in economics class, we all learned supply and demand and a company’s fundamentals drove financial markets. Sadly, the 2008 Financial Crisis ended that and the seven-year bull market that’s dominated since March, 2009 is perhaps the biggest fake bull market ever seen, perpetrated by a world reliant on central banks policy (especially the US Federal Reserve) that’s provided trillions of dollars in fake money, easy liquidity and confused a generation of traders unable to cope with the end of the wild ride. Without the need to fully understand “QE” and all the other jargon you’ve seen in the headlines, all you need to know is basically the central banks are quickly running out of ammunition to artificially prop up your investment portfolio and the next few decades will be challenging to say the least.
Sparing you any technical lingo, I’d be the wrong person to explain the details that back up what I’ve just written but for anyone interested, I highly recommend all of Michael Lewis’ books. Easily the financial industry’s best author, Lewis worked on wall Street and uses easily understandable language written for average people in all his books. Helping make sense of all the crap they spew out on CNBC, his candor is excellent and he’ll help you understand how to set your expectations. Don’t ever listen to Jim Kramer or any of the TV personalities. Like Rush Limbaugh and Bill O’Reilly, they only spit out rhetoric for the network’s benefit, not yours.
Normally not worrying about our portfolio, I’ll share another reality; timing is everything in life. Sadly, you can’t always control that but you can set yourself up for a better chance of success. Diane and I returned to the USA after six years in Canada in 2007, the start of the biggest financial market calamity of our lifetime. Fortunately, my 401k plan started on 1/1/2008 and Diane was lucky enough to take part in a 403b and a 457b (two similar tax sheltered retirement plans) starting in late 2007. Get to know the term “dollar cost averaging“. Simply put, it means investing at regular intervals throughout the year, allowing you to buy more shares when markets go down and vice versa. Paycheck deductions are the easiest and most painless way to accomplish this and I suggest doing the math so you’re investing for all 24 checks during the year (or 26 if you get paid bi-weekly). Although you’ll think you can’t afford it, always try to max out your retirement plans every year. Since we’ve always done that, we’ve never missed the extra cash because we never had it. For early retirement, you can’t afford not to do this.
Reiterating I’m no professional, I do know If you follow the plan outlined above, you’ll cut your taxable income significantly and here’s why. (Note this applies to US tax policy). Not only does maxing your retirement plans lead to large tax refunds since your taxes are withheld at rates that assume no reductions of annual taxable pay, it also frees up room to invest even more in a ROTH IRA.
If you’re unfamiliar with ROTH IRA’s, it’s worth reading up. Simply put, it’s a tax sheltered plan that allows tax-free withdrawals after age 59 1/2 assuming you’ve had all the principal you withdraw in the plan for a minimum of 5 years. The catch is you contribute using non-deductible post-tax dollars so you obviously need spare cash to use this tactic.
The IRS allows contributions to an IRA even if you contribute to a retirement plan at work up to a certain threshold but the catch is they use adjusted gross income to calculate eligibility. Diane and I earned too much gross pay to qualify, but by maxing our retirement plans and itemizing large allowable deductions on our taxes like property taxes on our home, mortgage interest and state payroll tax, we reduced our taxable adjusted gross income so much, it allowed us to then max out two IRA’s every year.
If you’re thinking we lived on a lot less than our earnings, you’re spot on. Using our highest earning wage year as an example, we contributed 44.7% of our gross pay towards our work sponsored retirement plans. Working for large companies helps because they usually offer quality companies like Fidelity who offer lots a supermarket full of good investing options and support but the point remains no matter who your plan is with. Our monthly mortgage payments accounted for 15.5% more of our pay and we made bi-weekly prepayments that ate up another 9.5% of gross pay. (Using a 15 year mortgage and prepaying diligently can have you debt-free in 8 to 9 years and then all the house money is yours to play with assuming you don’t buy another one of course). Leaving us only 19.6% of our annual gross pay, we lived a perfectly comfortable middle class suburban lifestyle, albeit it way below our means. Originally planning on retiring about six years later than we did, sacrificing expensive dinners out and watching free TV series available from our local library on weekends paid off handsomely when deciding to take the plunge at such an early age.
With one exception, starting a retirement at the beginning of a bear market is devastating to a portfolio and drastically decreases the odds of outliving your money without making major lifestyle changes and nobody wants to live poor after working their asses off for decades. Diane and I “officially” retired on May 15, 2015, the last day we received employment income. Checking the stats, you’ll notice the seven-year bull market’s top was May 21, 2015 (as measured by the S&P 500 index.) Normally a recipe for disaster, we lucked out by selling into a housing market short of supply and in more demand than anywhere in the USA.
Commanding five offers after one open house, we sold for 12.7% higher than asking price. Understanding everything I’ve written here, we smartly chose to sack the entire amount into the highest yielding CD’s available. (We suggest a large online bank; paying a sad 0.85% to 2.0% depending on the term, the rates are still twelve times the national average and your “too big to fail bank” will offer literally pennies in interest no matter how much you give them.) As for your investments, here’s what I know from experience:
In general, a well diversified investment portfolio with moderate risk (perhaps 65% in stocks, 35% in fixed income) will be worth about 1.6 to 1.8 times more than it is today in 15 years, assuming reinvestment of all dividends, little trading and no more contributions.
Believe it or not, the above statement holds true in any set of given market conditions. For example, Diane and I started our investing career with almost nothing in 1997. Catching the tail end of the tech boom, we then lived through the tech crash of 2000, the Enron corporate scandal years, the “US Treasury downgrade scare“, a host of other events that caused high volatility and of course, the worst calamity since the Great Depression known as The 2008 Financial Crisis. Through it all, we kept investing regularly despite market conditions although while we lived in Canada, we left our US assets mostly in IRA Rollover accounts and invested in the Canadian markets until we moved back and began new retirement plans from our new jobs.
Shown below, the two graphs show mutual funds we’ve owned since 2004 and 2001. The first one is a U.S. stock fund that invest in mid-sized companies; the numbers at the top show the yield over time (7.1% since 2004) and the numbers on the side represent the real “true” return on the investment including reinvested dividends (up 110%). The second one is in our Canadian portfolio, holds mostly Canadian bank stocks and some Canadian bonds. While it’s boring, notice the fund’s never had a major downturn including 2008. (Yield is 7.3%, value is up 150%; the dots show monthly reinvested dividends). Find what works and stick with it.
The last point I can share is perhaps the most important. Known as asset allocation, experts agree it’s the most important part of your investment portfolio. Again, please refer to professional websites for the nitty-gritty but it basically means owning the right mix of asset classes is more important than any individual securities because it helps shelter losses in a down market. Many people miss the main point, especially if early retirement is a goal; it’s not what you earn, it’s what you keep. Wealth preservation is far more important than capturing large gains in bull markets and we aim to lose no more than 50 to 60% of the broad market’s loss on any given down day.
Lately, that’s been very difficult and I’ve shifted some of my riskier fixed income (high yield, bank loan and foreign bonds) into classes that are ironically safer than most fixed income during the current run of volatility. At the moment, that means Ginnie Maes (GNMA’s) and bond funds investing in securities backed up by the US government housing agencies (Fannie Mae and Freddie Mac). Yes, the same agencies that started the mess in 2008 thanks to immense greed and Wall Street corruption are currently enjoying positive returns thanks to investor perception that the US housing market is “safer” than everything else. Ridiculous? Yes, totally. But if you understand how to look for trends and occasionally shift your asset allocation, hopefully you’ll lose less during the next 45% drop (and the current environment may very well be the early part of the next worldwide financial disaster).
Summarizing all this, returning to California in 2008 in the middle of a financial crash but with the start of a new bull market looming proved very lucky. Starting new self-directed retirement plans a few months before the bottom and seven years of investing allowed us to increase our net worth 168% by last year. Landing in Malaysia, we’ve now taken the scary switch from investing to capital preservation. With no more available income to invest, my personal research suggests our inflation adjusted investment portfolio should support a 30 year retirement when we’re actually old enough to use the tax sheltered plans without early withdrawal penalties. (assuming we live on 80% of what we did while working as most retirement specialists agree is reasonable).
Even with low fixed deposit rates, selling our overpriced California house was an enormously lucky windfall that should allow us about 13 to 15 years of living expenses before needing to use our small pensions and begin withdrawing from our investments. With longevity running in our families we may need to go as much as 40+ years with no employment income and our minimal pensions aren’t even close enough to support a middle class lifestyle. Admitting I’m a bit concerned about a possible catastrophic financial loss to our investments while we’re so young, I’ll take the high road and hope that while history is no guarantee of future performance, the elites that run the world’s capital markets will eventually step in and adjust to a new set of challenging circumstances like plunging commodity prices, sub-stratosphere returns from China and clueless central bankers out of ideas. Hopefully, we can avoid the Wal-Mart greeter option at age 80.
Comments and questions about anything I’ve written are more than welcome. Please keep in mind I have no crystal ball; just 30 years of watching the casino known as Wall Street.