Q. I plan to retired in June at age 60. The only retirement I have is a 401k which I will roll over into my IRA. That is with a discount broker. My 401k is about $132,000. I do plan to get Social Security at age 62. This will be about $710 a month. I will need about $1,500 a month to live on. I am pretty healthy so I have estimated 30 years. My question--- given my age and need, what types of investments should I be looking into? My risk tolerance is probably moderate.
--- I.M., De Soto, TX
A. With a long life expectancy, the best investment you can make is to continue working until you are at least 62. Preferably 65. Take a look at the difference:
- If you retire at 60, you will not have Social Security for two years. That means you will be withdrawing $18,000 a year from your savings in each of the next two years when your total return probably won't be more than 8 percent or about $10,600 a year. As a result, you would only have a little over $100,000 in investments when you started collecting Social Security and would need a return of nearly 10 percent a year from your investments--- a return that can't be produced year in and year out. The only prudent way to do your plan is to reduce your planned spending dramatically--- to about $1200 a month.
- If you retire at 65 your Social Security benefits will be at least 25 percent higher or about $890 a month. In addition, your 401k plan will have another 5 years to grow. Even if you save no additional money, that could mean a nest egg of about $200,000 which could produce a reliable income of about $830 a month for a total income of $1720 a month. This would have about the same purchasing power as $1500 a month today.
Q. There is something both my wife and I don't understand: why is it that if the interest rate on bonds goes up their market value goes down? It would make more sense to us that the higher the interest rate, the more valuable the bond would become. Can you explain?
---S.W., Dallas, TX
A. Lots of people find this confusing, mostly because they think all bonds are alike. But they aren't. A bond is a promise. The borrower agrees to return the lenders money in a stated period of time and to pay a fixed amount of interest at regular intervals until the bond matures. Suppose, for instance, that the U.S. Treasury needs to borrow $10,000 for five years and the market rate for such high quality credit is 6 percent. That means the investor has a piece of paper that will pay him $300 every six months for five years, a total of $600 a year.
Now suppose interest rates rise to 7 percent because everyone is worried about inflation ( or whatever). Then the Treasury will be selling pieces of paper that pay $700 a year or $350 every six months.
Query: if both investments were available in the marketplace would you be willing to pay the same amount of money to receive $600 a year as you would pay to receive $700 a year?
I don't think so.
As a result, the market value of existing bonds rises and falls with changes in interest rates so that older bonds have a yield to maturity that is virtually equal to the yield on newly issue bonds. If the interest rate on new bonds goes down, the value of old bonds goes up. Treasury bonds that were issued long ago to yield 13.75 percent until they matured in May, 2004 currently are priced over 142, meaning that a $10,000 bond sells for $14,200. Wouldn't you pay more for $1,375 a year in income than for $600 a year?
Since the buyer will receive $1,375 a year in interest on his $14,200 investment the apparent return is 9.7 percent. But that is an illusion because a current buyer will only receive $10,000 at maturity, not $14,200. Adjusting for the $4,200 loss, the real yield to maturity is only about 6.7 percent… about what you can expect from a new bond with the same maturity. All of this is much harder to see in a bond mutual fund because it is a portfolio of bonds.
Q. I wanted to ask a follow-up about the PhD. woman and work. To sell the home and receive a one-time $125,000 (or less) capital gain non taxable, do both the husband & wife have to be 55? What if he is over 55 and not she?
If they must both be 55, should they delay the sale until both qualify? Maybe lease the house for a period before the sale?
---K.H., Dallas, TX
A. Only one spouse needs to be 55. The lease question, however, starts the time clock running making it an investment rather than owner-occupied house. If you lease it too long before sale you won't have enough ownership months to qualify for tax deferral OR the exclusion on sale.
Best source on this subject is the Ernst and Young Guide, a Godzilla sized paperback. It gets really complicated when divorces, remarriages, and other forms of conjugal recombinance come into play.
File Name: 961017TH Dallas Morning News file date: 10/17/96---THU
Universal Press Syndicate file date: same ©
Dallas Morning News, Universal Press Syndicate, 1996
Scott Burns is the retired Chief Investment Officer of AssetBuilder, the creator of Couch Potato investing, and a personal finance columnist with decades of experience.