Making our Financial Plans Stronger

"What doesn't kill us makes us stronger." ~ Friedrich Nietzsche

Financially speaking, 2008 was a year that could have killed our financial plans. With the stock market down 30 to 40%, the value of our investment savings declined significantly. As bad as it was, our finances survived. I count us among the lucky survivors - no foreclosure, no credit card debt, and no bankruptcy in 2008.

While there are no guarantees that 2009 won't be as bad, I have made some changes to our financial plans to make them stronger. Here's what I learned from 2008 and the changes we are making.

If it's too good to be true, then it probably is. Actually, I learned this much before 2008 and the events of 2008 reinforced it. Here are a few examples from 2008: Bernie Madoff's consistent hedge fund returns, the higher returns of the Reserve Money Market Fund, and aggregating poor risk can create lower risks (e.g. CDOs.)

Change: Continue to be skeptical of investments that promote consistent returns better than the average or excessively high returns. Don't be lured into such investments to recover 2008 losses faster.

Keep a significant proportion in cash and bonds. It was assumed diversifying across uncorrelated assets would lower overall volatility and risk. In some cases, diversification was a simple as among domestic, international, and emerging market equities, because the economies were thought to be no longer correlated. In other cases, diversification was across asset classes, such as real estate, collectibles and other hard assets. However, in 2008, everything fell in concert, except for cash.

In spite of all the perceived risks of inflation and devaluation, cash turned out to be among the best asset classes of 2008. While cash earned as little as 0.5% in some accounts, that yield was much better than the 30-40% losses in other areas.Bonds also held up well since recovering, although they did decline significantly for a short period in late 2008.

Change: Divide savings between investable funds and cash equivalent/bond funds, e.g. 50% invested and 50% cash/bonds. Rigorously manage the proportions.

Reduce withdrawal rate. The 2008 decline in our retirement investments increased our withdrawal rate from 2.6% to 3.6%. Most financial advisors consider a 4% withdrawal rate safe and a 10% decline in our retirement savings will put us over 4%.

Change: Reduce our withdrawal rate in the short term by increasing wage income and reducing expenses. See Reducing Withdrawal Rate from Retirement Savings for more details.

I learned a lot from the bear market of 2008. Fortunately for us, it occurred early in our retirement, allowing us to make changes and (hopefully) to recover for the remaining retirement years.

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This is not financial advice. Please consult a professional advisor.

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