Far too many households have a one person financial team. Often, that person is involved in the investments, taxes, and even the day-to-day bills. In my house, this process is split evenly - or at least in my estimation - so that I am the investment and insurance guy; the wife is the taxes and day-to-day girl. It works out well for us on many levels. She controls how the household expenses are allocated and reins in the spending where necessary, mostly involving cell phone bills or more specifically text messaging done by the lone teen left at home. I handle the 401(k) plans, the IRAs and their direction and when the budget allows, the financial decisions about major financing such as autos and appliances.
But what happens when I am gone? What about the investments? How would she protect her money?
We have, unlike many couples, discussed how she should handle a future without me and this is the plan we decided on. Once the insurance money was paid to her, the Social Security checks began arriving, and the pension payouts began, she would have three choices.
She could stay in the house. While she bristles at the notion, insurance would cover any remaining mortgage and the left over could be put into a CD earning 2.5% that would cover taxes for some time. Her income would be covered through the remaining programs I mentioned earlier and further supplemented by retirement savings.
She could sell the house, taking the currently sizable equity and investing it in a CD which would give her enough income for the next twenty years to cover basic living expenses. Her standard of living however, would not rise and inflation, the economic act of making your money worth less, would eventually take its toll.
The insurance policy, however would need to be invested to assure that she would not outlive those moneys and the increasing cost of living to a ripe old age.
But where? Yale University professors Robert J. Schiller and Robert D. Arnott have found that the real return on the stock market over the last two decades or so came largely from what they call a revaluation of stock prices. In other words, investors believed that stocks during the period from 1980 to 2000 were worth more thus driving up their price. Whether these stocks were actually worthy of price increases is debatable, especially in light of the falling prices that followed in the year's after the study. But during those years, stocks on the S&P 500 gained 7.4%.
Should she chase dividends? In the Bush economy, the answer would be yes. The reduction in taxes on dividends and capital gains has fallen under this president's administration and if his promises are kept, they will be eliminated altogether.
Dividends, according to the professors added another 3.3% to the yield. Without those taxes and with the additional shift in corporate transparency - a nice phrase for spreading the wealth to the shareholders and not the officers of the company, some feel as though dividends will continue to increase. Putting a third of her money in this sector may prove enormously prudent but should be done through a segmented approach.
For instance, she should buy into a good index fund with low expenses at the rate of $2,500 a month. This will take over five years to completely invest a third of the $500,000 policy but she will be taking advantage of a principle I have beaten to death called dollar cost averaging. Dollar cost averaging spreads the price risk by allowing you to make purchases of mutual fund shares at different times. When share prices are low, DCA allows you to purchase more shares. Conversely, when prices are higher, you will buy less but those shares bought at the lower price will be more valuable.
While a goal of protecting her principle would lead to a conservative investment like bonds, she will also need to worry about inflation eating away at the returns. This can be a real deterrent to gains and could be protected if she took a third of the investable money and placed into a TIPS bond fund. These Treasury Inflation Protected Securities should be bought in a bond fund because of the laddering advantage these managers have over the common folk. Laddering simply means buying different maturities at different times, keeping your money working. For this portion of the investment, she could do a lump sum approach.
Just a side note about how TIPS work and how to calculate their value against regular Treasury bonds. Inflation that is rising increases the yield of the offering. For instance, a TIPS type 10 year bond might have a yield of 2.50%. A 10 year Treasury might have yield of 4.50%. Subtracting the difference on those yields will tell you how much your TIPS has been adjusted for inflation. If inflation is running 2.5% and this would be over the course of the next ten years - we are comparing decade long securities - a 10 year TIPS would have bested the conventional bond by 0.5%. I expect inflation to keep at about that pace over that period of time. How the 10 year bond performs depends on a wide variety of events, but that's another column.
What she should not do is buy an annuity. Anything placed in such a vehicle would not be inheritable for the kids or grand kids or any other place she wanted to gift her inheritance. Besides, the rates are horrible for the security they provide.
The last third of the insurance money should be invested in her. Of course, this is because I personally know of her unbelievable artistic talents, business savvy and tireless ambition. Using the remaining money to start her own business would not only keep her busy but would provide a good way to grow the money as well. She could draw a salary from it and in turn, save 25% of it in a SEP-IRA. And that should be direct toward REITs.
Even if she decides against the business, she should find a REIT or a fund that invests in them. Real Estate Investment Trusts are baskets of real estate investments from apartments to office space to shopping centers. They do have their ups and downs but the principle is essentially safe. REITs generally don't have price fluctuations the way stocks do but the returns can vary widely. Those returns usually outpace inflation so this portion of the investment may be the best invested third. This investment requires diversification but once again, a good mutual fund designed to hold REITs will provide a good group. She could also put this in as a lump sum.
If she keeps her will up-to-date and her eye on the quarterly statements, she will not outlive her money. All of the above mutual funds, the index, the TIPS fund, and REIT fund should have low expenses and reputable fund management. Her tax rate should be lower so tax management, while important will not be greatly impact her returns. In fact, she will probably be able to leave a good legacy to the grand kids.
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