Joe Hearn's Blog

Come on in. The water's fine.

During the bear market of 2000-2003, there were several months that I didn't even open my investment statements when they came in the mail.  I'm sure I wasn't alone.  Losing money is painful.  So painful that it can cause people to sell what they have and stop investing (pop quiz: What's more fun--A 401k account that is tanking or a new car?).

If you were burned in the recent bear market and quit saving for retirement as a result, consider what would have happened to a $10,000 investment made the day before these terrible historical events:

• Pearl Harbor was bombed on December 7, 1941.  A $10,000 investment made on December 6 would have been worth $34,728 after 10 years.  Today it would be worth over $21,000,000.
• President Kennedy was assassinated on November 22, 1963.  Ten years later, your $10,000 would be worth $22,945.  Today it would be worth $1,200,000.
• The Dow Jones Industrial Average plunged a record 22% in one day on October 19, 1987.  Had you invested $10,000 the previous trading day, you would have looked like an idiot.  Ten years later your $10,000 would be worth $44,269.  Today it would be worth $75,845.

Saving for retirement can easily take 40+ years and there are bound to be plenty of "reasons not to invest" along the way.  Don't be fooled by the headlines.  Almost any time is a good time to start saving.

Which half are you in?

According to the book Live Long and Prosper, half of all Americans incur 97 percent of all medical bills.  The other half incur 3% of the costs.  Unfortunately, I think I fall in the first half.  Factoring this into my retirement planning could require me to save hundreds of thousands of extra dollars just to cover my medical expenses.  The good news?  Most of the really expensive diseases are the result of lifestyle choices.  If I make the right choices now (eat right, exercise, etc.) I will likely be able to spend that money on travel rather than cancer treatments.  Time to hit the treadmill.

Diversification Part II: The Business Owner's Dilemma

Do you own your own business?  Try the following exercise.  Imagine all of your assets (the business included) shrunken down and sitting in a big pile on the floor in front of you. Now take the business and all of its related assets and move them off into a separate pile.  Now look at the original pile.  Is there much left in it?  If not, you may have succeeded in creating a great paycheck, but you have not succeeded in creating much wealth outside of your business.  Said another way, if your business (and the income it generates for you) ceased to exist, you would be making some serious lifestyle changes.

So short of selling your business and cashing out, how do you diversify your assets in order to minimize your risk?  Answer: Create a business outside your business.  Pay yourself a good salary, retain earnings in the business that are needed to operate it and help it grow, and then sweep the rest of the cash out and use it to begin building wealth independent of your business.  Don't just hope that the business will continue on and you'll eventually be able to sell it and cash out.  If that happens, great!  But until then, look at every week or month or year as an opportunity to cash out a little bit.  It works.  I have clients that have done this that now have significantly more wealth outside their business than in it.  All because they used the business as a wealth building tool instead of just an income generating tool.

Diversification Part I: Company Stock

My father-in-law called me last night.  He is one of the smartest people I know and has a great job with a company that is preparing to go public.  The conversation got me thinking about the risks and rewards of investing in company stock.  The rewards being that if a large percentage of your net worth is tied up in one stock and that stock does really well, you'll make a lot of money.  The risks being, well...Enron, WorldCom, Tyco, AOL, etc.  Many employees at those companies were hit twice; once when they lost their savings and then again when they lost their jobs. 

Take a look at your 401(K).  What percentage of it is invested in your company's stock (as opposed to diversified mutual funds)?  Would your retirement plans be effected at all if that portion of your account dropped in value by 50%?  How about if it went to zero?  If the answer is yes, you should probably meet with a qualified financial planner to develop a diversification strategy.

Tomorrow, in Part II, we'll take a look at people that own their own business.

Maximizing Potential

I'm a frequent reader of Seth Godin's Blog and he has a great post today that I thought you might be interested in.  I'm not going to spend a lot of words trying to relate his post to retirement planning.  I just thought it was a great concept that each of you could benefit from reading.

Social (in)Security

If you're one of roughly 80 million baby-boomers approaching retirement, you might be interested in knowing how old you need to be before you can collect full Social Security benefits.  You can find out here.

A lot of people choose to accept reduced benefits in exchange for taking them prior to full retirement age.  This may not be a great idea if you have a long life expectancy (see yesterday's post).  There is a good article on this subject on Dow Jones MarketWatch.

Of course if you're nowhere near retirement age, this is all a moot point because Social Security won't be there for you.  At least not in it's current form.  You can't sustain a pay-as-you go system when the worker-to-beneficiary ratio has fallen from 17 to 1 in 1950 to 3 to 1 today.  If you don't believe me, here's a little ditty from the Social Security website: "Social Security is not sustainable over the long term at present benefit and tax rates without large infusions of additional revenue.  There will be a massive and growing shortfall over the next 75 years."  Translation: If you're young, don't factor Social Security into your planning.  If there's something there for you, great.  If not, you won't be forced to live in a van down by the river.

Ain't modern medicine great?

I calculated my life expectancy this morning using MSN's Life Expectancy Calculator.  Thanks to modern medicine, it said I can expect to live to the ripe old age of 81.  If I retire when I'm 65, that means that I need to have a retirement nest egg that will last for 16 years.  "That shouldn't be a problem" I thought.  Then I used the calculator for my wife.  She's expected to live until she's 102.  Whoa!  That's 21 years longer than me.  So unless I can convince her of the merits of a Romeo and Juliet suicide pact, I need to build a nest egg that will last for 37 years.  How about you?  Will you have more money than life?

What's better than a crystal ball?

What is more important to your 401(k) balance: a) mutual fund performance b) asset allocation or c) contribution level?  According to a recent study by Putnam, contribution level is far and away the biggest factor (followed by asset allocation and then mutual fund performance).  The study took a hypothetical case from 1990 to 2005.  Picking best performing funds versus worst performing funds (hence the crystal ball) only resulted in 6% more wealth after 15 years.  Picking a more aggressive asset allocation resulted in about 20% more wealth after 15 years.  Increasing the contribution level from 2% of salary to 4% of salary resulted in a 100% increase in wealth.  Granted, Putnam telling us that performance doesn't matter is like the ugly girl arguing that looks aren't important, but they have a point.  The easiest way to have more is to save more.

No soup for you!

Northwest and their pilots have reached a tentative deal.  In addition to a 24% pay cut for pilots, the agreement would eliminate in flight meals for the crew.  Northwest has their back against the wall, so this isn't a knock against them, but if you're a pilot and they can't afford to feed you a $2 cheeseburger on your cross country flight, how confident are you in that $100,000/yr pension they're promising you?  A good reminder that relying on your company or the governement to fund your retirement can quickly backfire.

Clear writing reflects clear thinking.

I'm not sure who originally made that statement, but it is certainly true.  To that end, I am trying to organize my thoughts for my next book.  Book one was on preparing for the unexpected.  Book two will focus on preparing for the expected (namely retirement) and I could use your help.  If you have an interesting story, thought or question about preparing for retirement, email me.  You might just make the book.  In the meantime, I'll try to update the blog regularly with my own retirement related thoughts.