Financial Opinion and Insights

Own or Loan – Choose Carefully!

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

I remember when I first entered the business of financial advice in 1990, I went through `broker 101’ training with what was in those days Dean Witter.   One of the first things we learned was that there was only three things someone can do with their money:  They can own, loan, or consume.  Maybe the #2 thing was that every financial instrument in the world essentially is a stock or a bond.

When you loan money, you don’t get growth.  You get income, and a fixed one at that!

The choice is simple:  You can loan your money and collect interest and get the same dollar units back at a later date (worth less due to inflation), or you can acquire ownership in something that fluctuates but historically moves higher over time.   Real estate and ownership of quality companies are examples.

Nick Murray, in his book, Simple Wealth, Inevitable Wealth – a book I consider a `must read’ for anyone who truly wants to understand what the real path to wealth is, requiring of course that you turn off the `white noise’ of the idiot box – uses the postage stamp example.  Advisors have been using the postage stamp as a proxy for inflation for years; but, Mr. Murray’s example is one of the best:

Realizing that the average retirement age today is 62 and the average life expectancy is around 92 for a non-smoker, it’s today very reasonable to plan on thirty years in retirement!  

Well, in 1980 (okay, that’s 31 years, but you’ll still get the message), a first class stamp sold for 15-cents.  Suppose that 15-cent stamp was the only thing you had to buy from your retirement income (it represents your expenses in your first year of retirement), and the income from your CDs and bonds was 30-cents.  You’d be VERY happy.  Your CD and bond income would be TWICE what you need to live on.

Flash forward 30 years to 2010.  Even if interest rates had stayed the same – and we know they didn’t; your income would have declined to almost nothing – your 30-cents wouldn’t even buy a first class stamp today!  The first class stamp, our proxy for inflation, went up to 44-cents.  That’s about TRIPLE! 

In the meantime, far from your 30 cents income  providing you with  twice your cost of living, it’s now well below your costs – again IF rates had stayed the same – requiring you to cut back your living standard by almost a third!

But, of course, rates aren’t the same.  Your income from interest would have gone down to practically nothing –  you’d have been using principal just to pay expenses.  That’s how people run out of money.

But, aren’t stocks risky? 

Hey, what’s risk?  The example above shows inflation is the real risk.  In fact, it’s virtually a sure bet!  The next real risk isn’t our investments, it’s our own behavior.

Mr. Murray in his book points out that from 1990 through 2009 – a period that includes one of the greatest decades for stocks in history, followed by one of the worst – the average U.S. equity mutual fund produced an average return (with dividends and capital gains reinvested) of 8.8%; but, during that same period, the average equity investor earned an average annual return of 3.2%.

The best equity mutual fund in the `lost decade’ of 2000-2009, he points out, earned an average annual return of 18.2% per year , but the average investor in that same fund during the same period managed to LOSE 11% per year!   Reason:  Buying high after the run-up, probably based on the fund making all the `best-dressed’ lists in the media, then bailing out after the downturn.

Again, it’s about owning vs. loaning.  It’s about the long term.  It’s about our behavior.

People thought real estate was safe until the meltdown; then no one wanted to buy even with rock-bottom rates!   My first home cost me $62,000 in 1978.  It’s now valued at $325,000, even in this terrible real estate market.

All good financial planning begins with four basic questions:

  1. How much monthly income will you need to take from your investments during the first year of your retirement.
  2. When do you plan to retire?
  3. How much do you have set aside now (retirement plans, other accounts, etc.)?|
  4. How much do you feel you’ll be able to contribute on a monthly basis until you retire

It’s only a starting point.  But, that’s where all journeys begin.  And, how you get there from here is what counts.

You can’t avoid risks – get that out of your head – but you can manage them.

Hope this helps!



Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained herein should be regarded as tax or legal advice and the reader is urged to seek competent counsel to address those issues.   The above represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a formal financial and investment plan.   For questions or comments, you can reach Jim at 805.265.5416 or through the IFG website, http://www.indfin.com.