Ask the Blogger: Save For Retirement, or Keep Working?

The markets are stagnant, the economy is notso hotso--why not just keep working instead of socking money away?

Dear Blogger:

20 years ago I was fresh out of college, very responsible, fully funded my 401k and got the company match. Now I'm 40 and after starting a small business that sailed right into the recession, I find myself with: * a house worth a bit less than $500k * a mortgage for around $175k * no 401k (cashed out - yes, I know all the math. It was the right decision.) * total assets beyond house : $12 in my pocket * total debt beyond mortgage: $0 * running a small business with a lifestyle that I like, but a salary around $75k/year, when I could make $110k/year as an employee or $180k/year as a contractor. Given my studied conclusion that we're heading into a lost decade (or, more likely, a lost quarter century as we deal with the demographic crisis, the welfare state crisis, etc.) I see minimal returns to stocks and far prefer to invest by paying down the mortgage (I plan to be done with it by age 47). Given that I am a "knowledge worker", I don't mind having a lower income and lower takes and working till I am 70 or 75, rather than working more, saving more (in an uncertain environment with potential monetization of government debt destroying much of the value of my savings) and hoping for a retirement. I.e. I am doing the opposite of income smoothing: I am leisure smoothing.

Smooth (Business) Operator

Dear S(B)O:

As a journalist, I am in no position to ever advise anyone to go for the money; spending your life writing is the ultimate in expensive lifestyle choices. If you can cover your household expenses with a comfortable (15%) cushion, and your business is not too variable, you should absolutely follow your bliss. Like many of us confronting forty, you have undoubtedly realized that 70-80 years is not such a long time as it sounded when you were 22, and you should enjoy those precious years as much as possible.

However, you should be more diversified than you are. Right now your assets are a small business, apparently considerable human capital, and a considerable amount of equity in your house. Absolutely continue paying that house off, but you are too concentrated in the human capital side and your home. Yes, yes, the best investment you can make is in yourself, but sometimes that investment goes sour. Talk to bankruptcy attorneys and you'll hear a lot of stories about doctors, lawyers, and tradesmen who lived up to the edge of their income--and then got sick and couldn't work.

You don't mention how much insurance you have, but at a minimum, as someone who is self-employed (I'm guessing in the technology field), you should have a generous disability policy. Knowledge workers like you and me often neglect this because our jobs aren't dangerous, but the problem is that if you or I can't do our jobs, it's because something has screwed us up so badly that we probably can't work at anything. And social security disability does not replace much of a healthy income like yours.

This is also the big problem with planning to work into your seventies. That is not a bad plan--I think more people should follow it, and certainly hope to do it myself. But as you age, the odds of something really debilitating, like bad cancer or a stroke, inevitably rise. Not everyone is able to work into their seventies, which means you need a backup plan. Even the most generous disability insurance will give out at 65. That means you need assets--which aren't the place you live--to cover expenses you might have. If you're still working at 70, fantastic! Treat yourself to a terrific vacation or a fancy car. But if you aren't, you'll be glad of the extra money.

I share your worries about the path of growth over the next ten years. But unfortunately, that argues for more saving, not less. If returns are going to be dispiritingly low, you need to defer more consumption today. I recommend a 401(k), IRA, and/or SEP containing a boring mix of domestic and international stock funds, transitioning towards bonds and CDs as you age. Remember that the tax benefit of these plans essentially gives you an automatic guaranteed return, so even if the market doesn't go much of anywhere over the next ten years, you'll have done better than stashing the stuff unde the mattress--or in a rapidly depreciating motor vehicle, or other consumption, as you may be tempted to do if it's where you can get at it.

If you are really adamant about not putting money in the market, and you think you know your local real estate market pretty well, you can look into becoming a rental landlord; millions have done it successfully. But this can be a lot of hassle, and it leaves you exposed to local housing prices. And if you do go this way, you should do it with cash, not by borrowing--the housing crisis saw a lot of overleveraged landlords lose everything.

You will probably not get rich this way, but you also won't get evicted in a tax sale or a bankruptcy. In most states, if you did suffer a big financial setback and had to declare bankruptcy, the amount of equity you have in the house would allow creditors to seize the house and sell it to satisfy your other debts. As we learned over the last few years, even houses aren't "Safe as houses".

If you have dependents, you also need enough life insurance to replace your income; 7-10 times annual income is the general requirement. This will not be a bank breaker provided that you are in decent health. And even if you have no dependents, you need a beefier emergency fund. Businesses go through cash flow problems. You need to have enough in the bank to tide you over. In a situation like this, you should be working on accumulating a year's worth of expenses in an FDIC-insured bank or money market account.

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Those savings will, of course, be vulnerable to inflation. But I don't expect 10% annual inflation any time soon. And other investments

Ultimately, all of this means that you probably need to cut your consumption a bit to provide a more diversified savings base, including insurance for death and disability. You should factor this into your decision about which job to take. Otherwise, you're "consuming" a lot of hidden risk. People get away with it all the time. But lots don't--and those people are really in a world of hurt.