What Are The Risks That We Are Missing?
REDUCING PORTFOLIO RISK WHEN APPROACHING RETIREMENT
What Are The Risks That We Are Missing?
One of the greatest fears many people have is running out of money in retirement. Sometimes fear causes us to make less than ideal decisions. Some people put their money into an annuity so that they will have a constant stream of income.
If you are investing in stocks for any significant length of time, then you have seen market drops of 40-50 percent. And it can take years to recover. What happens when you retire and are trying to make withdrawals from a smaller nest egg? If the withdrawals remain the same to maintain your standard of living, then you will be taking out a larger percentage of the nest egg to live on.
Inflation Risk
Some financial planners point out that one of the greatest risks to a retiree is a stock market bear market in the first couple of years after retiring. It can take years to recover. Although most bear markets recover within four years of the fall, that is a long time to wait just to get back to even.
I think that inflation is a greater threat because it is more permanent. We have seen prices for gas, housing and groceries exceed the official inflation numbers. How much more income does it take to maintain your purchasing power?
Losing a pension or Social Security benefits
This may be the most overlooked risk to your portfolio.
A few months ago someone in our neighborhood had a heart attack while driving a golf cart. He spent the next several days in the ICU before passing away. His widow was afraid that she would not be able to afford to remain in the neighborhood because she could no longer afford the mortgage without his income.
My father-in-law lost his life in an accident when he was only 59, less than two years away from retiring.
How would losing a spouse affect your income or cash flow? Can the surviving spouse manage the portfolio? Life insurance gets more expensive as we get older. Even term life policies can become more expensive, outweighing the potential benefits.
This is not meant to be a downer, but there are many risks we need to be aware of as we plan for retirement and financial independence.
THE SECRET – CASH FLOW IS KING
After spending years, maybe decades, turning our nest egg into a portfolio of significant value, many people are asking, “How can I turn this portfolio into something we can live on?” Or better yet, how can it be turned into an income stream they can thrive on and live out their dreams?
After all, even a mountain of cash will only last so long if it is not invested. So how can we turn this portfolio into the cash flow that we want? It’s time to recognize that cash is not king. CASH FLOW IS KING.
Here are a few ideas to consider.
ONE. KNOW YOUR BUDGET.
What are your monthly expenses? What expenses are given, such as mortgage and utilities? What expenses are discretionary, such as vacations and travel? Knowing this breakdown can help you decide how much cash flow you absolutely need from your investments every month, and how much can be more random, such as long term capital gain windfalls.
TWO. SHIFT FOCUS TO INCOME, HEDGE FOR GROWTH
During the years when building our portfolio we focused on growth. Buying properties using the BRRRR strategy worked well. That is, Buy, Renovate, Rent, Refinance and Repeat. That gets more challenging as interest rates have risen. The high leverage and some cash flow can work well for growth, but we want cash flow to cover our monthly expenses and ensure Financial Independence
Free and clear properties produce cash flow with less risk than leveraged properties. Natural appreciation can ensure rents continue to rise with inflation. This maintains your purchasing power with the cash flow from a given property.
Some leverage can help maintain equity growth beyond the inflation rate. For example, a good house might cost $200,000 and rent for $2,000 per month. What if you put $100,000 down on each of two houses? Then you get to enjoy the appreciation and equity buildup of two properties with the same cash out of pocket.
Single-family homes like this can be like annuities but better. Similar in that they can provide a steady cash flow. Better because the return on investment tends to be better and rises with inflation. If the stock market drops 40-percent then you can still have your cash flow.
Another option is to become a private lender. This can be done with smaller amounts of cash. Benefits can include regular interest payments. Many of these loans are secured by mortgages, just like loans from the bank. They can offer good returns and many investors would prefer to work with private lenders instead of banks. Some of my favorite lenders loan from their Roth IRAs and earn tax-free income.
Yet another option is investing in a real estate syndication. Some of these investments offer investors a preferred rate of return that can provide income while the investment continues to grow. Investment minimums tend to be significantly less than paying cash for a property.
THREE. LEVERAGE YOUR TIME
When approaching Financial Independence and Retirement, it is worth asking how much you want to be involved with your portfolio. Some people enjoy watching the stock market every day and choosing their own stocks. Personally I think there are too many professionals already doing the same thing. That is a tough market to compete in and I have no knowledge of what the individual companies are really doing.
Do you want to be a landlord dealing with tenants and toilets? This can be offloaded to a property manager.
Private lending to real estate investors can be beneficial as discussed above. An investor can do all the work and manage a property. And you avoid the tenants and toilets.
One of my favorite ways to leverage time is investing in real estate syndications. The investment sponsors handle the property management, often through a property management company. Investors are relieved of the need to handle tenant calls. Another benefit is that investors can invest in real estate without using their personal credit.
As you reach Financial Independence and retirement, how do you want to be spending your time? How active or passive do you want to be managing your investments and portfolio?
HELP US GET TO KNOW YOU BETTER
How are you preparing to have the cash flow that you desire for Financial Independence and retirement?
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Mike is a retired aerospace engineer with a passion for real estate investing and teaching financial literacy. He lives with his wife in Daytona Beach, Florida.