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What if I don't die soon enough?

Retirement Funding - A Layered Approach

Background

When it comes to saving or investing for retirement, there are many, many different approaches. Many of them good, many of them bad. But in the end, very few people will be able to retire comfortably. Most people take a dip in income when they retire, whether they are middle income in America, or survival level in South Africa.

IF they are able to retire at all.

Unfortunately the problem is going to get worse, and I do not see a systemic path for the situation to improve, unless the world goes the UBI route. And that is a discussion for another day.

The reasons it will get worse, include the following:

Fewer and fewer people are in formal employment, where some kind of pension plan is available.

Even for those people that do have a pension plan, pension plans have mostly moved from defined benefit, to defined contribution. It means that in the past, the plan rules defined how much the fund would pay you once you have retired. In the new environment of defined contribution plans (e.g. 401(k) plans) the rules of the fund defines how much the employer pays in, and after that pensioners are on their own. But not only have employers abdicated their defined benefit responsibility, they have also greatly reduced the amounts that they pay as their contribution, compared to what they paid in the previous dispensation.

People are living longer and longer.

High level approach

My assumption is that even if you have a stable secure job, with a pension plan, that that will not be enough. You will need to save more, and you will also need to save for all your goals that you have defined in your

life plan⁠

My next assumption is that you will also manage these funds, and not simply put it in some mutual or exchange traded fund and hope for the best. How intensely you manage those funds is again based on your personal preference, but at least you would like to grow in your ability to manage your savings.

Lastly, I assume that you are not a financial guru that can trade options in the morning, shares in the afternoon, and currencies on the international market overnight. You are a reasonably intelligent human being, that wants to take control of their financial future to the best of their ability.

Therefore:

One should follow an approach that will lay a safe, secure foundation. Even if those initial investments do not pay a large return, you need to start safe. As you achieve the initial low-risk goals, you read up a little bit about what the kind of investments are that you can make when you start the next layer. You have at least a few months in between each layer, sometimes years, so there will be ample time. And you repeat this process as long as you are comfortable with taking on more risk.

Start

Before we start, one more aside. There are two dimensions that we need to look at as far as risk goes. The one dimension is the learning curve. You want to start out with low risk, secure investments while you gain experience, and then you escalate risk gradually. The second dimension is what we call your "cash flow risk". This is to make sure that you always have enough cash ready when you need it. For example, shares go up and down, and we expect that, and accept that. Therefor, we need to plan ahead, so that we do not have to sell shares when the market is down.

The layered approach addresses both concerns, as you start with simple, easily accessible savings.

Step 0 - Read, read, read

You become good at what you do. Whatever it is that you are doing, you will get better at it. If it is watching sport on TV, if it is jogging on a regular basis, or if you are reading, studying and implementing financial strategies.

Step 1 - Emergency fund

The emergency fund is some money that you keep aside for the bumper bashing. or the new washing machine, the broken arm or whatever small emergency occurs that immediately has to be dealt with.

How much it should be is a completely subjective question. Maybe it is about as much as your co-pay on a car accident, or a visit to the emergency room in the hospital. In the USA, the typical guideline is $1,000, but if you earn $7.50 an hour, that is going to be a stretch.

The reason for this is because it provides us with comfort on different levels - first a sense of accomplishment when the emergency fund target is achieved - step one, done. Also, it provides a bit of comfort in the back of your mind, when you know you can handle life's small emergencies. And finally, once that emergency arises, and you can handle it, it feels great.

If you had to use the money, replace it as quickly as possible.

Investment account - This money should go into an immediately available savings account. The interest rate is bad, but the purpose is not to earn interest, the purpose is a little bit of financial security and peace of mind.

Credit cards - At this stage I would not pay off any credit card debt that I have, but also do not increase your debt. It is more important to get the goal of "Emergency money" achieved.

Step 2 - Free fall money

Free fall money is the highly technical financial term that my wife uses for the money that is available to live on between jobs - the small unemployment periods. For Free fall money people generally recommend 3 to 6 months of your expenses. This will hopefully tide you over until such time as you can find a new job, pay to kit out the new baby room for the unexpected pregnancy or give you the time to recover from a heart attack or car accident. However you should gradually extend that level to 12 to 24 months, and keep it there throughout your retirement. That will isolate you from short term market fluctuations in your share portfolio or interruptions in your real estate rental flow once you start living on your investments.

Investment account - Again, this money should go into cash accounts, with some kind of government guarantee behind them, where available. Say 3 months into an ordinary savings account, and the rest into a money market account, or a term deposit with a 3 month or less notice period.

Credit cards - At this step, you should also address your credit card debt, because that carries an interest rate of many multiples what you will earn in the savings or money market accounts.

Step 3 - Next level - Growing an Investment Portfolio

Once you have your 3-12 months worth of free fall money in place, it is time to move to something a little bit more serious. There are two large popular directions that investors follow, the one is real estate, the other is shares. I believe that you should have both in your portfolio, but you should initially focus on one, and get that implemented. After you have one down pat, you need to diversify into the other

Step 3A - Real Estate.

With investing in real estate, I have in mind the buy-to-let side of the industry. Development and flipping are businesses, and not investments.

The big advantage of real estate, is that you can obtain good leverage on your investment. The two main disadvantages is that you need a relatively large sum up front, and the second is that you need to deal with tenants.

(See also my comments in the blog post

Should I invest in property?⁠

)

Step 3B - Share investments

The advantage of share investments is that you can start with really small amounts, and with relatively low risk. I would recommend that you start with a generic ETF or Index Fund. As your nest egg and experience grows, you can diversify into more niche funds, and later individual shares.

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