You've done your homework and prepared for the day you turn
65. With the help of compound interest, mutual funds, tax shelters
and insurance products you've reached your goal.
Then you expect the hard-earned money you've put into solid
investments to keep you basking comfortably in the light of those
sunset years. But how long can you really live off the income of
your retirement fund?
Your calculations should reflect three important themes --
inflation, taxes and longer life expectancies. And quite likely,
you will have to consider asset protection as well in this
The world is constantly changing. Your retirement plans will
have to be able to adapt to new realities.
How much is enough?
It depends, of course, on your lifestyle and how much the
things you aspire to have will cost. But let's take a modest
amount of $50,000 a year, about double the per capita annual
income in the United States, or an engineer's annual wages in
Chicago. We assume the Federal Reserve will do its job the way
it has in recent years and inflation remains at 3 percent,
compared to 5 percent in the past 15 years. If our fictional
portfolio returns 6.15 percent annually after taxes, our saver
needs more than $700,000 to stretch his retirement money 20 years
out. At this spending level and return, a fat $1 million can get
him to his 97th year.
These figures apply if his last paycheck is in the mail, or
if his retirement is not too far off. Otherwise he has to adjust
for inflation again. The dollars he earns today won't buy him
the same amount of goods in 15 years. Taking a 3 percent annual
cost of living adjustment means he'll need $78,000 in 15 years to
buy $50,000 worth of goods in today's dollars. With $500,000,
he's likely to be bankrupt in his early 70's; with a million,
he's good for another 17 years or so from the day he retires.
No, even a million won't be enough if he lives 20 years
longer -- and he just might according to actuarial tables.
But isn't inflation beaten
Inflation has come down significantly and in Europe and
Japan, deflation is touted as the new ogre. But it would
certainly be premature to say inflation is down for the count.
In developed countries, central banks are reflexively loosening
their monetary grip at the specter of recession. There is no
assurance that the current drive to increase liquidity won't lead
to inflation, if not now then in later years. In developing
countries, inflation is still an everyday household word. And as
these countries grow, and at the rapid pace some of them have
been keeping, demand for increasingly scarce raw materials could
push global prices up.
While the recent relentless rise in food prices on commodity
markets is largely due to weather conditions, rising standards of
living in rapidly industrializing countries may also tip the
balance of food supply and demand. For the past 20 years, this
balance has been the product of having half of the world go at
least a little hungry.
With China alone making up a quarter of humanity, its
growing economic power and ability to finance all the grain
imports the population needs could easily lead to excess demand
in world grain markets. Higher inflation paced by food prices
While the above scenario is relatively benign nasty
surprises can and do occur. Another oil shock, for example,
cannot be ruled out. Not its inflationary consequences.
Demand for oil is mounting. In the past 10 years, China
increased its per capita consumption of oil 33% and India, 50%.
Fortunately, oil supply has been relatively stable in the same
period. But, recent reports suggest it may not always be so; oil
stocks in OECD countries at the end of last year were at their
lowest levels since at least 1980. According to the
International Energy Agency, future oil price movements hang
largely on the extent to which these stocks are rebuilt.
So planning for some moderate level of inflation is a
prudent investment strategy. The dollars you save have to work
for you just as hard when you're no longer working, maybe even
harder. You'll have to be able to afford the things you'll need
even if inflation multiples their cost.
The burden of living longer
Demographic trends have been a primary reason for the
instability -- if not bankruptcy -- of government-sponsored
pension schemes in the graying developed world. Individual
investors are faced with the reality of the social safety net
being pulled out from under them, or at least severely curtailed.
But also, longer life spans mean that an investor's private
portfolio will now be burdened with the task of having to provide
income and security for much longer retirement periods.
Alternatively, there is a chance that you -- or your spouse --
will live long enough to regret the investment mistakes you make
with your pension funds.
Longer life spans call for a radical change in investment
thinking. The conventional wisdom of financial planning is that
once you retire, you ought to invest heavily in fixed-income
assets. This has become an outdated concept. If you can now
expect to live 20 years after retiring, your investment horizon
at age 65 should still be looking towards the long haul. Modern
medicine has made it worthwhile taking greater risks in order to
increase returns on your investments. The alternative is to let
inflation eat into them in the extra time you have. Inflation
and demographics tends to equalize differences in investing
strategies among pre-retirement investors and retired ones.
Suckers and Sharpies
An American economist, Arthur Okun, wrote in Inflation: The
Problems It Creates and the Policies It Requires (New York
University Press, 1970):
"Our financial system ought to serve both investors who want
to earn maximum returns (and are willing to take substantial
risks) and holders of reasonably safe assets who view their
saving largely as deferred consumption. The latter are not
accommodated during inflation; we thereby lose 'savers'
surplus.' Inflation creates in this way an unhappy division
of savers into 'sharpies' and 'suckers'... The former make
sophisticated choices and often reap gains on inflation
which do not seem to reflect any real contribution to
economic growth. On the other hand, the unsophisticated
saver, who is merely preparing for the proverbial rainy day
becomes a sucker."
The seventies are seemingly a bygone era, but Mr. Okun's
views remain relevant. In Okun's terminology, we all must strive
to be that sophisticated saver, the Sharpie. Unless you are one
of the lucky few, someone who won't have to worry about
stretching his nest-egg benefits because he expects to or already
owns the chicken coop, you need to invest in assets whose dollar
income or dollar value can be expected to increase as the
purchasing power of the dollar falls. Okun's views speak
strongly for diversifying retirement assets and diversifying
globally into non-dollar assets.
Specifically, Sharpies look at investment classes with
higher returns (even at greater risk) or at investments
denominated in an appreciating currency. Applying their
strategies most likely will require that you cut back on your
bond holdings. The most common retirement securities investors
own, long-term government bonds (e.g. US Treasury or UK gilt-
edged bonds), are the least inflation-proof in any country marked
by a history of spiralling prices.
Other fixed-income securities -- triple-A corporate bonds,
US annuities and endowment insurance policies -- which have
traditionally been a good means of generating income are also hit
by inflation. These would still provide a stream of income, but
the buying power of that income -- when it's really needed --
will be reduced by inflation.
And the winner is...
Sharpies know from their lessons in financial history that
the value of equities is more likely to appreciate over the long
haul than that of fixed-income assets. And when taxes and
inflation are calculated, stocks win hands down; investors lose
money on Treasury bills and bonds.
It should be noted that stocks do not always beat inflation,
even over long periods. Looking at the performance of the DJIA
and the S&P 500 index in nominal terms and in constant 1995
dollars one will find that in the latter case, at the peaks
around 1905, 1929, and 1964, stocks failed to recover against
inflation within the next 20 years.
The period after those peaks were partially marked by stages
of accelerating commodity price increases as well as high capital
gains taxes, which wiped out increases in share prices.
Today, no one can predict how close to the peak stock
markets are, nor how quickly they will recover if 1929 should
repeat itself. But since inflation is currently at a moderate
level and there is even talk of a "flat tax" which would
eliminate capital gains taxes, stocks should have more room to
grow in inflation- and tax-adjusted terms. But as we've
discussed, the inflation scenario may still change. And so long
as governments exist, taxes may still rise. So where do
Sharpies, those flexible creatures, go?
They go global, of course. Diversifying internationally is another Sharpie hallmark. Since 1971, the Sharpie would most certainly have lived up to his reputation by diversifying into
Copyright © 1996 by Jurg M. Lattmann
Reprinted with permission from
Swiss Perspective: Strategies for Financial Security and
Growth, April 1996.
Much more information on Swiss investing is available at