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The name of the game as a retiree is cash flow. Because you are no longer generating annual income to pay your bills, investments that provide consistent cash flow start to look more appealing than their long-term, appreciation-based counterparts.
This is why a lot of advice focuses on buying bonds before entering retirement. You will need guaranteed annual dollars coming in, and you also don’t want to gamble with higher volatility when you have less time to ‘make it back up’ in the long term.
So here’s what absolutely sucks about retiring now.
Like every retiree in previous generations, you are on the hunt for nice steady cash flow which often comes in the form of fixed income investments like bonds. Unfortunately for you, interest rates are at historic lows. A retiree in 2000 could buy a 20 yr treasury note with an interest rate of 6%. Unless the government defaulted, you were guaranteed 6% a year. Joy! Celebration! Your major risk in buying these notes is that the United States Government doesn’t close up shop and default on loans they backed with their name. If you believe the US will keep chugging along, you get to sit back and enjoy your 6% draws for 20 years!
Today, the 20 yr interest rate on a treasury note is 2%. It sucks to be a lender in the year 2016, which is what you become by buying bonds.
Let’s illustrate the difference in what that interest means. Say you need $50k a year to cover your expenses.
- To generate $50k a year assuming your money can make you 6%, you would need a nest egg of $833k.
- To generate $50k a year assuming your money can make you 2%, you would need a nest egg of $1.6 million.
That’s almost twice the amount!
Assuming interests stay low for the long-term, you would have to work another lifetime to make up for the fact that you want to pursue a majority bond strategy like retirement experts suggest to you.
Let’s take a look a closer look.
Check out a historical chart of the treasury yield. This chart uses the 10-year treasury note, which can stand in for the trend across all maturity lengths.
Source: Federal Reserve Board of Governors via FRED. Annotations by Yours Truly.
Many of the classic retirement books were written in higher interest rate environments, where the strategy of buying long-term bonds and living off the interest was a viable one. That is not the case today.
In effect, this and a lot of advice you will run into is given in a time capsule. Advice is often unique to the conditions in which the author or advice giver lived.
Dumping your money directly into long-term CD’s or treasury notes is not a viable strategy for us even if it were one for some of the retirement experts whose books we read.
It’s incredibly important in taking charge of your own finances to understand the why behind a strategy, and part of that why is the context of market conditions in which that strategy flourished. When did your idol retire? What were they able to invest in to solve their annual income needs and were those conditions unique to that time period?
Sometimes it’s hard to see what factors matter until they actually change. At The Money Habit, I try very hard to cover what I think are the key factors that drive a strategy so that if they change, a reader can know instantly that they may have to re-evaluate their approach. But like anyone else, it’s entirely possible I’m missing key drivers simply because they’ve been this way for as long as I and all the research I’m reading can remember. The likelihood of a government defaulting would probably have been not even worth a single breath thinking about. Then the Greece default and bailouts happened. While I still feel very comfortable backing the US government, I am now more cautious about my approach towards foreign government bonds. Who would have thought?
You will have to be the one that had that thought. Or at least do your best to have those thoughts. You’re in the driver’s seat.
So let’s say you believe all this. Now what? What exactly are you supposed to do about it if you’d like to retire soon? We cover the best options in an accompanying post here.