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Beth Can’t Live on Only a Million Dollars

Roger McClure Dec. 14, 2017

Beth has a million dollars and does not have enough money to live on.  She even owns her own house in the Washington DC suburbs and owes nothing on it. 

To live in the Washington DC area, you need a minimum of $40,000 for a simple happy retirement lifestyle if you own your own home outright.  Beth has her investments in instruments she thinks are very safe: Certificates of Deposit at Mega Bank. She earns 2% on her $1,000,000 which provides her $20,000 a year in income, covering her real estate taxes, home insurance, utilities, car insurance and maintenance but this leaves nothing for food. Food comes from her $10,000 a year in Social Security.  Sadly, she can’t afford to travel to see her grandchildren in California.

Beth thought by saving her whole lifetime and retiring a millionaire, she would have it made for a happy and prosperous retirement.  Being a saver, Beth is not a big spender. She doesn’t change her furniture every year or buy new outfits with each change of season.

Beth suffers due to the artificially low interest rates of 1 to 2%. Blame it on government policy, world wide over capacity, the new economy or phases of the moon; but, knowing for sure why interest rates are low does not solve Beth’s problem.

Beth reliably needs $60,000 a year to live in her DC suburb.  That means she needs to earn a reliable $50,000 to $60,000 every year on her $1,000,000.

Beth is scared by the stock market and is afraid that there will be a market crash soon and she cannot afford to lose a quarter to half of her $1,000,000 in a stock market nosedive.

She consults a well-qualified financial planner who introduces her to laddered bond funds.

What are laddered bond funds? It is a selection of a series of bonds issued by major financially solid corporations.  If Beth buys a one-year bond for $100,000 which pays 6% annually, after one year, she then has her $6,000 in interest and her $100,000 in cash back from the corporation.  She will also look at bonds for two, three, four years and more.  The collection is called a “ladder,” each rung representing the number of the years until the bond is paid back.

Her financial planner carefully reviews the safety of each bond and comes up with a ladder of investment grade corporate bonds that will safely provide Beth $52,000 a year on her million. With her social security of $10,000 a year, Beth will have enough to live on and see her grandchildren. 

In talking with Beth, the financial planner learns that Beth has to have a dependable amount of income each month. The planner rules out a bond mutual fund whose payouts vary over time due to the purchasing and selling of bonds in the bond fund. Instead, the planner chooses enough bonds in the ladder to provide Beth with diversification to protect her from possible defaults of one or more bonds.  Also, the short term of the bonds from one to four years lessens the risk from an unpredictable reversal of corporate fortunes of these highly rated solvent businesses.  

Why not just get one 30-year bond for $1,000,000?

First, by putting all of one’s eggs in one basket should that one company default, you could lose all or most of your invested money. Secondly, when inflation returns as predicted, the value of your bond drops because the income paid on the 30-year bond is less than inflation-driven bonds you could buy in the future because the newer bonds are paying a higher interest rate and therefore worth more.  In contrast, with a bond ladder of a diversified portfolio of bonds with varying maturities or terms, the maximum risk that Beth is exposed to is what may happen through the term of her bond ladder.

A well-rounded plan may also include some stock equities, some Real Estate Investment Trusts and other financial instruments to provide growth in the portfolio, which the bond ladder does not.  Beth also needs her financial planner to brief her on any downsides of bond ladders so she can make an informed decision.

There are other solutions for people struggling with retirement finances such as moving to another part of the US with lower living costs, or for the adventurous, moving to another country where $30,000 a year provides a very good lifestyle.

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