I was meeting with a potential client when he surprised me by commenting, “You’re really conservative, aren’t you?” The couple was retiring with pension money from work, and had chosen to work with me over two other advisors. We had talked about this money lasting them for the rest of their lives, and they explained to me that there is really no room for mistakes. I felt the same way. It’s not like we’re playing Monopoly and, if we get behind or lose, we can just start the game over.
This is real life and we only get one chance to make it work. It turns out that the husband had played Monopoly so often as a child, that he wore out the money, the cards and even the board. They then made their own pieces. He understood that there is a time and place for taking risks. Everyone has made some mistakes, but the time for that was behind us. That’s why he chose to work with a professional on the majority of his money. Since he enjoys making investment decisions, he will retain a couple small accounts where he’ll place his own trades through a discount brokerage.
The goal, similar to Monopoly, is to produce enough income from their investments to last for the rest of their life. There is no shortage of choices. We determined that, net of fees, they would like to earn a 7% income from their invested funds. I put together a recommended portfolio of common stock that, on average, yielded 7.45% net of fees. In this way, they don’t need to sell down the capital in order to meet their income needs. At the same time, it provides a small cushion of excess income that will either grow their funds, or provide income for one-time needs. Since they’re not selling shares, they still have that ability as a backup plan.
The husband, who has a more aggressive approach than his wife (which is normal), asked about using some of the equity in their home to invest. He could arrange a loan at under 4% interest and they could invest it at 7% (or better) income. I agreed that the math works and they would come out financially. But, in line with the idea that there’s no room for error, borrowing money magnifies mistakes. If dividends were cut or stopped or if share prices fall, it could have a much larger impact on their financial plan than if they pay cash for their investments. Besides, keeping their borrowing room available gives them a second backup plan, should they ever be in a position to require access to additional cash.
In my own planning and investing, I am somewhat less conservative. I buy investments with higher uncertainty, in order to get higher income and the chance for greater gains. I borrow money when I see a buying opportunity, knowing that I have the earnings to pay it off in under a year. But when I give professional advice, I want to minimize the variety of things that could go wrong. I prefer producing excess income for a buffer, having the option of selling investments as a backup plan, and using little or no leverage so that there is always something to fall back on. It’s an unfortunate commentary that, compared to some salespeople, that advice is considered conservative.
How conservative are you in your planning?