Unlike traditional investing, where you commit your money and hope for the best, Pension Guard investing is done with a timetable that matches your cash needs to a schedule of guaranteed, inflation-protected securities.
Suppose, for instance, that you have a corporate pension that pays you $40,000 a year. You'll have this pension for as long as you live, which makes you a very fortunate person. The purchasing power of your pension, however, will decline each year. After 5 years, for instance, you'd need to have $45,000 to have the same purchasing power you had at the start with $40,000.
That means you'll be short $5,000 in the fifth year--- if you don't have that much additional money, your standard of living will decline.
Query: What can you do to make certain the money is available?
Answer: You immunize. Just as the more intelligently managed pension funds schedule their expected cash needs for long periods of time and invest in securities that will mature when the cash is needed, you and I can buy securities that will assure the right amount of money when we need it. The process of matching future pension liabilities with pension investments is called "immunizing"--- it works to protect pension managers from nasty surprises.
What kind of securities are good for Pension Guard investing?
It depends on the type of account. If you are investing in an IRA rollover account where all income is tax deferred until withdrawn, you can invest in Treasury Inflation Protected Securities (TIPS). You buy an amount for each year that will deliver the funds you will need at that time.
If you are investing your regular taxable savings, the best tool is I Savings Bonds, the Treasury bonds that pay a modest yield over the rate of inflation. If you assume 3 percent inflation with no real return (over the inflation rate) in the first five years, you'd need to invest $4,461 today to provide $5,000 in five years. Similarly, if your pension purchasing power will have declined by $12,200 in 10 years, you'll need to invest $9,300 today.
Then you add the amount needed each year for the number of years you want to assure and your purchasing power is safe.
Well, pretty safe. How much you need to put aside depends very much on the inflation rate you assume for the future. Guess right, and you'll have exactly the amount of cash you need, when you need it. Overestimate the rate of inflation, and you'll put aside too much money. Underestimate inflation, and you won't have put aside enough money.
We can't get this perfect; we can only get closer to the target. Since the rate of inflation is far less volatile than stock prices or long term bond returns, making a good inflation guess will improve your planning over guessing the future returns of stocks and long term bonds.
So you can make assumptions and see how much you need to invest each year, I've built an on-line calculator that does all the heavy lifting for you. Enter your pension, your inflation assumption, and the real return on your investment choice, and the Pension Guard calculator will tell you how much you need to invest to protect your pension for periods as long as 30 years.
And that's where you realize the impact of slow inflation. For every $1,000 of pension income, you'll need to invest $1,200 to protect against purchasing power losses for 10 years and $2,500 to protect yourself for 15 years. That means a retiring worker with a $40,000 pension would need to commit $48,600 to assure purchasing power for 10 years, or $101,600 to assure purchasing power for 15 years.
How many years of purchasing power should you protect?
That's open to debate, but I'd say 10 to 15 years, max.
While stocks, on average, have returned 10 to 11 percent a year, compounded, the return in any single year varies a great deal. The longer your investment period, the higher the probability your return on stocks will be greater than the rate of inflation. Of the 70 ten-year investing periods between 1926 and 2004, for instance, large common stock returns beat inflation all but 9 times, usually by a large margin. Of the 65 fifteen year investing periods between 1926 and 2004, large common stocks beat inflation 61 times. In both instances, the bad investing years included the inflation of the 70's.
On the web:
Sunday, part one of this series TBA
The Pension Guard Calculator: TBA
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