How to Reduce the Risk of Outliving Your Money
Americans are living nearly as long as ever. With a life expectancy of 78.4 years, there is good reason for any American to believe they will need to save for a long post-retirement life. However, this begs the question: How can you be assured that you will have sufficient money to maintain your lifestyle after you stop working? Luckily, there are a few easy steps to ensure that your bank account’s demise doesn’t precede your own.
Don’t do debt
Dave Ramsey, a nationally syndicated talk show host, has built a career out of a singularly simple maxim: Don’t fall into debt, and if you’re in it, get out. While there are situations where it may make sense for sophisticated investors or productive businesses to take advantage of low capital costs, for the most part, individuals should follow Mr. Ramsey’s advice and stay out of debt.
One reason for this is that debt is the opposite of compounding returns. Compounding returns are the goal for any investor. But when someone enters into debt, the compounded interest accrues against them. This may seem like small potatoes during times of low interest rates. But even many relatively low-interest 20-year mortgages end up being mostly interest payments when all is said and done. Carrying even a small amount of credit card debt at 20 or 25 percent can be financially devastating, and that’s not even the worst part.
People tend to have strong biases against accurately assessing low probability, high-impact events. The reality of today’s economy is that there are major disruptions to every industry. Just because a job or career has been there for 20 years doesn’t mean it will be there the next year. Debt loads that work perfectly fine with a given income can cause total disaster when that income is disrupted. The worst outcome of debt is losing all of the equity you have in the asset which was borrowed against. For most people, those assets are their cars or homes. For most debtors, a layoff or firing can quickly lead to missed payments. The threats of foreclosure, repossession and court judgments, including garnishment orders, make debt a far riskier proposition than many people are aware.
Invest in long term holdings
Once you’re out of debt, you can begin to build real wealth. The beauty of redirecting interest payments into equity investments is that the mountain-moving force of compounding returns begins to work for you, not the bankers. Over the past 100 years, the stock market has returned an annualized 10.4%. This means that if someone saved $100,000 from all of their debt and interest payments, then stuck all that money in an index fund, in forty years they would have $5,200,000. That’s more than enough to live just about any reasonable lifestyle for a very long time.
The best way to save money, of course, is to live below your means. Simple things like buying a five year old car instead of a brand new one or even living in a cheap apartment until you can save enough to pay cash for a small house can make the difference between being able to accumulate wealth and falling into intractable debt.
The most powerful force in the world is the ability to compound positive returns, year after year. Staying out of debt and living below your means puts you on the road to compounding your returns and accumulating real wealth that will be there until your last days.