I am a thinker – thinking of ways to do things better and thinking of ways to prevent disasters, reduce risk, and reduce worry. of course many ideas end up being a flop. However, sometimes, an idea comes along that actually seems to work!
One such idea is a concept I have thought about for years and interestingly, it was a concept that I later learned was the focus of the work of one my BU teachers (Francois Gadenne) whose instruction I enjoyed immensely. The idea is simple: if you have enough funds to create a “pension” or as my teacher would say, a “floor,” then it would be prudent to create that rather than risk one’s entire retirement stability to the market. And as we know, some folks who retired at a certain time were luckier than others – someone retiring in 1999 who moved all his money to government bonds saw wonderful growth AND income over the past 10 years. Someone who planned to retire in 2002 or 2008 caught a financial “beating!”
The floor idea is simple (I previously called it a “pension-like income stream”) – take some of your retirement portfolio and place it in vehicles that will will provide the targeted income needed for necessities in retirement, thereby ensuring a “floor” of income, and then take the rest and invest it for “upside,” a.k.a. growth in order to try to enhance your retirement income and quality of life. We do this because when considering financial planning, which means intelligently and unemotionally planning for contingencies, we avoid the macho temptation to put all of the money at risk, especially if there is enough money saved to ensure a baseline level of living!
Why not just leave the money in CD’s or bonds and live off the interest? Well, first off, rates of return are LOW. Also, from a tax point of view, these are lousy choices outside of an IRA (because of exposure to income tax, the increases to AGI which could reduce schedule A deductions, it potentially causes social security to be exposed to tax, etc.). And I know in places like Medford, MA, where I live, the cost of living marches steadily higher and I have seen MANY retirees experience a quality of life “erosion” as their interest-bearing investments get rate haircuts on renewal or maturity. If the cost of heating, food, insurance premiums, gas for the car etc all fell when interest rates fell, this might be ok – but they don’t (thanks Ben Bernanke!).
Creating a floor ensures that something will be there because guaranteed vehicles such as Treasuries are used to make this happen. If you are close to retirement, and you are unsure about your portfolio and its safety, look at the various risk management strategies, including what Francois, my teacher calls “Floor plus Upside.”