De-Leveraging

You've probably known people that you assume have about the same income as you but seem to live much more extravagantly. Maybe they own a bigger house, drive two new cars or take a couple of exotic vacations a year.

Although we can't know their financial situation for sure — maybe they do have more wealth than us — these households are sometimes described as having a "highly-leveraged lifestyle." What we typically mean is that they may be spending most of their income and not saving much. In a financial emergency, like a job loss or medical crisis, these families might burn through their savings pretty fast.

Before we retire, we could measure our "lifestyle leverage" by the number of months our savings would last if we suddenly lost our job. Fewer months means higher leverage and more risk.

We might cut back on discretionary spending in an emergency, but non-discretionary spending (the mortgage, food, etc.) often makes up the bulk of our budget and it could be difficult to significantly extend our savings in an emergency by cancelling HBO.

Furthermore, discretionary spending reduces savings, so being able to eliminate some of it in an emergency only solves half the problem.

The greater our lifestyle leverage, the greater our risk of a financial crisis or mortgage foreclosure before or after we retire.

There is a different way we can look at lifestyle leverage after we retire by using the calculations from sustainable withdrawal rate studies. The greater the percentage of our savings we spend annually, the greater our risk of outliving them.

I calculated the following portfolio survivability rates using the spreadsheet at the Retire Early Homepage. (This website has been around so long they call it a "homepage". That's a good thing. It's time-tested.)

Following is a chart of this data. As you can see, risk increases exponentially with the spending rate. That means that a small decrease in spending results in a disproportionately large decrease in risk, the probability of portfolio failure.

Retirees spending 5% of their portfolio value each year have a 24.7% probability of depleting their savings in thirty years. Those spending 10% less, or 4.5% a year, lower their probability of portfolio depletion to 8.2%. A 10% reduction in spending reduces the risk of portfolio depletion by 66.7%.

This works on a smaller scale, too. Reducing spending 2.2% from 4.5% to 4.4% reduces risk 29%.

Risk is highly leveraged when spending changes. Trimming spending a little can reduce risk a lot. And conversely, of course, spending a little more can increase your risk more than you might expect.

(An important point about these calculations. Wade Pfau showed in Say Goodbye to the 4% Rule, that future safe withdrawal rates may be closer to 3% than 4%. That will shift this curve significantly to the left. But while you may be able to spend less to get the same risk of portfolio depletion in the future, lowering that spending should still show an outsized reduction of risk.)

There are a number of ways to de-leverage our lifestyle, or said differently, to reduce the amount of spending from our stock and bond portfolio as a percentage of portfolio balance, after we retire. We can decrease the numerator (spending) or increase the denominator (savings).

Any reduction of spending, including cancelling HBO and limiting lattes will help by lowering the numerator (spending), but it will probably be difficult to meaningfully reduce risk by minor trimming.

Leverage is also reduced when we have a good year in the stock market (increasing the denominator) and increased when we don't.

Downsizing our home may both increase the denominator by converting home equity to more liquid investments and reduce the numerator by lowering house payments.

Paying off the mortgage may also reduce leverage, sometimes significantly. Paying off the mortgage will reduce spending, but it will presumably reduce the current portfolio balance by the amount of the mortgage payoff. Whether and to what extent the leverage ratio will be improved depends on whether the ratio of the current principal and interest portion of your annual house payments to the mortgage payoff amount is greater than your current spending ratio. You can usually find these numbers easily at your mortgagor's website.

(Downsizing your home may result in lower principal and interest payments, property taxes and insurance costs, but paying off the mortgage will only lower principal and interest payments.)

Here's an example.

Assume your current mortgage payoff amount is $100,000 and you pay $5,000 a year in principal and interest (P&I). The ratio is 5%. If you currently spend 4% a year from your stock and bond portfolio and have an adequate balance to pay off the mortgage, doing so will improve your lifestyle leverage, meaning it will lower your withdrawal rate and decrease your probability of portfolio failure.

Any P&I-to-Payoff ratio of 4% or less would not improve lifestyle leverage in this scenario.

The ratio of mortgage P&I to the mortgage payoff amount changes over time with a fixed rate mortgage. The payoff amount continually declines as you make payments and P&I remains constant, so the ratio grows over time, making it more likely that paying off the mortgage will improve your withdrawal rate.

For example, assume you take out a 30-year, $100,000 mortgage at 4%. Your annual payments would be $5,729. The first year of the mortgage, you would pay about $3,970 interest and $1,764 in principal. At the end of year one, the payoff balance would be $98,239 and the relevant ratio would be $5,729 / $98,239, or 5.8%.

At the end of year 10, the payoff would have declined to $78,784 and the P&I-to-Payoff ratio would have increased to $5,729 / $78,784, or 7.3%. When this ratio of P&I to payoff balance exceeds your portfolio spending rate, paying off the mortgage will improve your lifestyle leverage and reduce your chances of outliving your savings.

Any reduction of spending as a percentage of your current portfolio balance will lessen your risk. That means you have to also keep a careful watch on your remaining savings. Even with constant spending, your withdrawal rate will move up and down with your portfolio balance.

What does this mean in a nutshell? Portfolio depletion risk increases exponentially with the spending rate. Cutting costs even a little can have a big impact on your financial security. This is one more reason to consider downsizing your home or paying off the mortgage, but any spending reduction will help.

De-leveraging is an important tool for managing retirement financial risk. For under-savers, de-leveraging and maximizing Social Security benefits are likely to be the two most effective ways to maximize your assets.

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Pay Off the Mortgage, Right?

My last two blogs, Investing the Mortgage and Selling Stocks to Pay the Mortgage, delved into the mechanics of holding a mortgage and simultaneously holding an investment portfolio. My intent wasn't to advise that you should or should not pay off the mortgage, but rather to explain the bet, and to show that it changes after retirement.

The proposition is essentially this:

"I bet that I can earn enough money investing in stocks and bonds to equal my mortgage payments and, further, to provide enough profit in excess of those payments to adequately reward me for exposing my home to greater foreclosure risk."

History shows this isn't a great bet, that it certainly isn't easy money, and that it becomes a worse bet after retirement.

So, everyone should rush to pay off the mortgage, right?

Not necessarily.

If a wealthy client asked me if she should take out a mortgage on an unencumbered home for the sole purpose of leveraging her stock portfolio, I would not hesitate to say, "Absolutely not." Had she already retired, there is an even stronger case for forgoing a mortgage.

On the other hand, for a less wealthy household, paying off an existing mortgage might convert most of her liquid assets into illiquid home equity. Freeing up cash from home equity can be challenging. (A fixed rate mortgage, it should be noted, is a temporary solution to that problem.) Maybe I would recommend keeping the mortgage.

But, maybe I wouldn't.

Lawrence Kotlikoff, who built E$Planner, says that he has analyzed many mortgage payoff scenarios and he most often sees an improvement to the household's standard of living, though not always. This is more of a cash flow than a profitability analysis and I would see what consumption smoothing says about the client's finances before making that recommendation.

Regardless, many retirees will eventually pay off their mortgage and have to face the illiquidity problem. They may find that most of their wealth is tied up in home equity. Better to plan for it up front. The most effective solution may be downsizing or relocating. It may not be a mortgage issue, at all.

Should you pre-pay the mortgage instead of investing? I wouldn't advise my son to pre-pay instead of investing in a 401(k). The amount of money we need to save to retire comfortably is so large that investing in risky assets is the only realistic way to get there. Pre-paying the mortgage is too conservative an approach. You have to take the risk. But, once you feel that you have saved enough for retirement, or you actually retire, you no longer need that risk.

After you retire, however, if you hold investments that could pay off the mortgage, you're relying on future stock returns instead of a paycheck to pay the mortgage and that's riskier. You're betting your home that you will succeed in exchange for a net expected return that is lower than your expected portfolio return by the amount of your mortgage. Your net expected return will be sharply lower than that of your portfolio return, but your risk will be the same¹.

As sustainable withdrawal rates studies showed, the higher the spending rate from your portfolio, the greater your risk of outliving your savings. Paying off the mortgage will probably reduce your withdrawal rate and thereby decrease your risk of depleting your savings. (I'll go into this "lifestyle leverage" in greater detail in a future post.)

Taxation may also be a consideration, though frequently a second-order problem after retirement. Consider taxes part of the calculation, not a certain justification for keeping a mortgage.

Lastly, there is a risk tolerance issue to consider. While many retirees will be comfortable with a higher withdrawal rate and more exposure to foreclosure risk, many will not. To quote a recent commenter on this blog,

"I am SO glad, now that I am retired, that we didn't load up on mortgage debt that we'd now have to service. Our house got paid off 6 years ago and wow, does that make a difference in retirement security. "

As you can see, there is significantly more to consider than expected portfolio returns and current mortgage rates when you consider paying off the mortgage. I would want to answer the following questions:

• Will paying off the mortgage significantly improve my standard of living?  (Calculate with E$Planner.)
• Will I have adequate liquid assets after paying it off?
• What is my foreclosure risk before and after a payoff?
• What is my portfolio withdrawal rate and risk of portfolio failure before and after payoff?
• Will I sleep better knowing my home is paid off?
• What are the tax implications of paying off the mortgage and of not doing so?
• If I am still accumulating retirement savings, will paying off the mortgage leave me with too little market risk to achieve my goals?

When is the right time to concurrently hold a mortgage and investments that could pay off that mortgage?

If you're very wealthy, paying off the mortgage seems like a no-brainer. If you insist on portfolio leverage, open a margin account. 

If you can't afford to pay it off, I suppose that's a no-brainer, too.

It's always the group in between that has the tough call. Investing the mortgage may not be the best bet, but sometimes it's the best bet on the table.

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¹ Mathematically, we are subtracting a constant mortgage payment from a random variable representing our portfolio return. That random variable might have an expected return of 8% and a standard deviation of 12%, for example. The result of the subtraction is another random variable with an expected return of 8% minus the annual mortgage payment, but the standard deviation (risk) of the initial portfolio return random variable will remain unchanged. Lower return, same risk.

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Selling Stocks to Pay the Mortgage

In my last post, Investing the Mortgage, I showed that the profit from borrowing a mortgage and investing the proceeds in the stock market is far more complicated to predict than simply subtracting the mortgage rate from the expected rate of your portfolio return. In fact, historically, this strategy would have resulted in a wide range of outcomes, the financial definition of risky.

I repeat the chart of outcomes from that post below. Note that the worst case outcome was a $37,333 loss, the best case was a $133,287 gain, and the median profit from this strategy would have been $26,937. (If you haven't read Investing the Mortgage, I suggest that you do so first. It explains the analysis in more detail.)

Once we retire and begin paying the bills from a portfolio of stocks and bonds, there are two subtle changes in our finances that can have a significant impact on the profitability of mortgage-to-invest.

The first difference is that we can't really borrow money and invest it in the market — not all of it, anyway — because we have to start paying it back almost immediately from our investments. If we borrow a 4% fixed rate thirty-year mortgage of $100,000, the payments will be about $5,724 a year and we will reduce our portfolio by that amount annually. The average amount of the $100,000 that would remain invested each year over a ten-year period would be a little more than $74,000. With less money invested, of course, our portfolio will grow more slowly.

When we pay the mortgage from future paychecks, as I modeled in the last post, we have the luxury of leaving all of the borrowed funds in the market for the entire 10-year period. If the market goes up, as we hope, holding more stocks will earn more money.

The second difference, which may be less obvious, is that spending from a stock portfolio over time, to pay the mortgage or anything else, creates sequence of returns risk. (See my posts on the topic if this is unfamiliar to you.)

Here's an example.

The following table shows the historical sequence of returns a 50/50 portfolio would have experienced from 1981 through 1990. The second row shows the least advantageous sequence of those same returns (sorted smallest to largest) for an investor spending down a stock and bond portfolio. The third row shows the best case sequence for this investor (returns sorted highest to lowest).

(Double-click to enlarge the table.)

In all three scenarios, the compound growth rate is the same, 8.7%, and that would be our return if we didn't sell stocks along the way to pay the mortgage. Without portfolio spending, there is no sequence of returns risk. The terminal portfolio value will be the same regardless of the order of the returns.

However, if we assume that the retiree has a portfolio valued at $100,000 and is spending say, 4% of the initial portfolio value each year ($4,000), then her portfolio value at the end of this 10-year period would be different in all three cases. The historical value of the portfolio would be $168,470, the best possible outcome would have been $184,820, and the worst $147,988.

This range of values that results from reordering the returns is sequence of returns (SOR) risk. It isn't "good" risk. It can't be diversified away and we aren't compensated for it by the market. And like SOR risk in retirement portfolios, early losses have a disproportionately bad impact on the mortgage-to-invest strategy outcome.

The combined impact of reducing stock exposure and adding sequence of return risk can be fairly dramatic. I altered the model from my last post such that mortgage payments are made each year by selling stocks and bonds from the portfolio, as a retiree might do, instead of paying them from salary and only selling stocks at the end of ten years, as someone still working would.

In the following chart, I compare the historical outcomes of the mortgage-to-invest strategy using a $100,000 mortgage assuming the investor is still working and paying the mortgage from salary (the blue columns from my last post) with the historical outcomes assuming a retiree pays the mortgage by spending down a portfolio of stocks and bonds (red columns).

The median profit from this strategy during the 10-year rolling periods from 1928 through 2013 declined from $26,937 to $9,374 when the mortgage is paid from stock sales instead of one's salary. This isn't surprising, given that this strategy significantly reduces the amount we have invested in the market over time. The best and worst cases are shown in the table below.

As you can see from the chart above, mortgage-to-invest can be a fairly risky strategy. You can lose a lot of money even when you pay the mortgage from salary. Even if you're still working, a $100,000 bet could have resulted in a profit of $133,287 if you executed it from 1989 to 1998, or a loss of $37,733 if you employed it from 2000 to 2009. That's pretty risky.

After you retire and begin selling stocks to pay the bills, the outcomes are even worse. You lose more in worst cases and your expected return on this strategy dropped 65% over the studied period.

The analysis is pretty much the same, by the way, if we inherit $100,000 and decide to invest it rather than pay down the mortgage, or if we simply decide to continue to hold a stock portfolio and owe a mortgage simultaneously.

A couple of observations. First, many people will find it difficult, before or after retirement, to pay off the mortgage by selling their investments. Maintaining some reserves and liquidity are important, too. We can argue that if paying off the mortgage requires converting too much of your wealth into illiquid home equity that you should consider downsizing, but life isn't always that neat. Paying off the mortgage isn't the right answer for everyone.

Second, for many households, mortgage-to-invest isn't an intentionally chosen strategy, but one that simply developed over time. You bought a house with a mortgage. You invested in a 401(k). You retired and began paying the mortgage and other bills with portfolio spending. Your risk increased unnoticed.

In either case, it is important to understand the risks and rewards and at least consider the alternatives of downsizing or paying off the mortgage if those are options for you. The analysis isn't as simple as "I have a 4% mortgage and I can earn 8% on my investments."

Regardless, as I mentioned in Investing the Mortgage, this strategy increases the chances both before and after retirement that you will lose your home to foreclosure risk, which, in my opinion, trumps any other home financing risk.

I have another basic concern with this strategy after retirement. While it makes perfect sense to borrow a mortgage when we are young, expecting to pay it back with future job earnings, it is a riskier proposition to borrow a mortgage and expect to pay it back with future stock market earnings.

I often point out that our finances change significantly after we retire and we can't view them through the same set of guidelines as before. This is a prime example.

In my next post, I'll discuss when you might want to make this bet.

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Investing the Mortgage

Can you borrow a mortgage at 4%, earn 8% in the stock market with the borrowed funds and pocket a fairly certain 4% annual profit? 

This comparison suggests that the two percentages (growth rate and interest rate) are applied to the same balance each year. The math isn't nearly that simple. After the first year, those balances are unlikely to ever be the same again.

Mortgage interest is calculated by multiplying the interest rate (4% in this case) by the current principal balance, which declines predictably and gradually for the first ten years or so, but is paid down faster over time. Portfolio returns are calculated by multiplying a highly variable annual rate of return by a current balance that can grow or decline substantially over time. They're two very different animals.

The simple math would work better if the earnings were risk-free. But, when the annual returns vary as stock returns do, the math switches from simply subtracting percentages to dealing with random variables.

To explain my point, I modeled real stock and bond returns and historical mortgage rates¹ for 76 ten-year rolling periods from 1928 to 2013. Each year, I assumed that an investor borrowed a 30-year fixed rate mortgage (FRM) at the average mortgage rate that year and held the mortgage for 10 years. (The average mortgage gets paid off after about 7 years.)

I assumed that the investor then invested the $100,000 in a portfolio of 50% S&P 500 index and 50% 10-Year U.S. Treasury Notes. At the end of ten years, the investor cashes in the portfolio, pays off the mortgage balance and I calculate his profit or loss, as shown in the chart below.

Although the annual FRM mortgage payments remain a constant dollar amount throughout the term, I converted those payments to the value of dollars from the first year of the period. In inflationary times, mortgage payments get paid with cheaper dollars over time, and with more expensive dollars over time when there is deflation. The model accounts for this.

The average mortgage rate during this time was 7% and the annualized real return on the 50/50 portfolio was 4.6%. The annualized nominal 50/50 portfolio gain was 7.8%.

If portfolios returned 7.8% and mortgages cost 7%, you might expect this mortgage-to-invest approach to generate a 0.8% a year profit and if lots of people had tried this at lots of times since 1928, the average gain from this strategy for all of those investors combined would have been about 0.8% annually. 

But, if you were one of those investors, you might have seen gains much different than 0.8%. A $100,000 investment earning 0.8% for 10 years would generate a gain of $8,294. Instead, you would have ended up with one specific outcome from the chart above. Those outcomes range from a loss of $37,733 to a gain of $133,287. The median profit was $26,937.

Nearly 40% of the outcomes were below the return you might expect when portfolio returns exceed mortgage rates by 0.8%.

A range of outcomes that broad is far from risk-free.

If we sort the periods by mortgage rates, about 8% of the negative outcomes occur when the mortgage rate is below the median of 5.8%, demonstrating that the strategy can lose money about one out of twelve times even when the mortgage rate at which we borrow is historically low.

The failure rate, however, increases to 17% when mortgage rates are above the median. This suggests an obvious strategy: don't mortgage to invest when mortgage rates are historically high, but that should be obvious. 

The failure rate is 22% when the market return for the 10-year period is lower than the median 4.74%, and only 3% when returns fall into the upper half. These returns aren't knowable when you invest, of course, so this information doesn't help with your investment decision. Market returns explain about 90% of profitability and mortgage rates explain about 20%.

The worst case outcome was the 10-year period beginning in 2000 when 30-year mortgage rates were 8% but the market would only return a real 1% per year for the following decade. The mortgage-to-invest strategy would have shown a $37,700 loss. 

The best outcome came from executing the strategy in 1989 when mortgage rates were at 10.3% and the market would return 11.4% annually over the boom decade of the nineties. The strategy would have shown a profit of more than $133,000. That's an enormous range of outcomes, which is to say that it's a risky investment.

William Bernstein has noted that an individual's success in financing retirement is largely dependent upon the year when he or she is born. The magnitude and sequence of investment returns can change dramatically if those returns are shifted a single year.

Starting a ten-year period with this mortgage-to-invest strategy can also be greatly impacted by a shift of a single year. Take a look at the ten-year period beginning in 1987, in which this strategy netted a profit of $59,388 and the one beginning in 1988 that netted a $106,937 profit, an increase of $47,549. Why such a large difference?

As you can see from the following table, the period beginning in 1988 jettisoned the 3.18% portfolio loss in 1987 and added the 19.22% gain from 1997, resulting in an improvement of outcomes near $48,000 if you started a year later. The strategy worked much better from 1988 to 1997 than from 1987 to 1996, even though mortgage rates were nearly identical at 10.2% in 1987 and 10.3% in 1988.

Don't overlook foreclosure risk.

If you mortgage your home so you can invest in stocks, you increase the risk that you will not be able to repay your mortgage and lose your home to foreclosure. The risk is multiplied when the failure of your mortgage-to-invest strategy coincides with an economic downturn, which is highly probable. Failure of this strategy means you probably had a high mortgage rate and/or experienced low market returns. Your chances of losing your employment increase at those times, as well.

Late in 2007, home values crashed, stocks crashed and unemployment soared simultaneously. A lot of people lost their homes.

The answer you get when you subtract a constant 4% mortgage from a random variable like 8% expected market returns is not 4%. It's another random variable with an expected return of 4% but the same standard deviation (risk) as the market. In other words, a significantly lower expected return than the market, but the same amount of risk.

As the chart shows, there will be a lot of winners and a lot of losers when you look at the entire sample results. Using this strategy, however, you will become one or the other, not the average.

I am not recommending that you do or do not "mortgage to invest". I only suggest that you understand the risks and rewards before you do. This strategy is far from a sure thing.

This is not ground-breaking analysis. I present it for two reasons. First, many readers will not have read the previous studies and should be advised of the risks. And, second, this example builds the foundation for what I really want to talk about: the difference between implementing this strategy while you're still working and executing it after you retire.

I'll cover that in Selling Stocks to Pay the Mortgage.

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FOOTNOTES:

¹Mortgage rates were downloaded from FRED back to 1972. Prior to 1972, mortgage rates are estimated from 30-year US Treasury Bond rates.

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When “Probably” Isn't Good Enough

Financial planners have long discussed whether we should pay off the mortgage, or keep a mortgage and invest that capital in the stock market.

The naive argument is that one can borrow a mortgage at say, 4%, and invest the money for a 10% return in the stock market, netting 6% on the “arbitrage”. But paying off a 4% mortgage is risk-free. (It is not a function of stock market returns.) The 10% market return in this example has a standard deviation of 20%, far from risk-free, based on historical market returns since 1926.

If you could find a risk-free 10% and keep the mortgage, that would be a certain 6% net and true arbitrage. But, that ain't gonna happen.

You would, in fact, earn the 6% difference in the years in which you receive the expected market return of 10%, but half of annual market returns are expected to be more than 10% and half less.

The meaning of “10% expected return with a standard deviation of 20%” is that in about two out of three years the returns will fall within the range of a 10% loss to a 30% gain (+ or - one standard deviation from the mean). That means the net return after the 4% mortgage payments will fall between a 16% loss and a 26% gain two out of three years. In 2007 to 2009, market returns fell way over to the wrong side of two-thirds of returns.

The worst financial mistake I have made in retirement (I should add “so far”) was taking the advice of a well-known financial planner in Washington before I retired in 2005. I could have bought my retirement home with cash, but he convinced me to hold a mortgage and leave that cash in the market. He gave me this advice because he thought the market would probably return about 10% a year on average over the life of the mortgage. But probably isn't the same as certainly and average isn't the same as annually.

Two years later, in 2007, the stock market crashed. Had I paid for the house with cash, I would have had hundreds of thousands fewer dollars exposed to the stock market.

The housing market crashed, too, but I don't plan on selling my home for a very long time, so that wasn't painful. Even the stock market crash was tolerable because I held a quite large helping of bonds. But it bugged the hell out of me that I had borrowed money against my home and paid a lot of interest for the privilege of losing that borrowed money in the stock market and that I was advised to do so by someone I trusted.

Fortunately, I could handle the losses. The former home of a good friend remains empty to this day after that housing and stock market crash. I see it every day, falling into disrepair. His mortgage was foreclosed, which brings up the most important reason I know to not borrow a mortgage to buy stocks. If you buy stocks on margin and the market crashes, you may have to sell some of your stocks and take a loss. If you buy stocks margined with your home and the market crashes, you can lose your home.

My friend had a lot of money going into 2007. It didn't seem at all likely that he would lose his home within a year.

Losing my home is high on my list of unacceptable outcomes.

I just found a 2011 article by Michael Kitces entitled Why Is It Risky To Buy Stocks On Margin But Prudent To Buy Them "On Mortgage"? This column and the comments adequately vet the issues, so I'm not going to repeat it or start a similar thread here. The issue I actually want to bring up is one of the magnitude and probability of risks.

The Retirement Income Industry Association  (RIAA) describes this in perhaps the most stilted prose you can encounter. I include it here for your literary amusement:

“The diverging opinions about the value of flooring in practice may derive from the range of opinions – that cannot be proven a priori – about a practitioner’s (or a client’s) view of the primacy of the probability of failure vs. the magnitude of failure. Some believe that the probability of failure looms greater in people's minds than the magnitude of failure. Others believe that consequences always trump the odds. There is no way to tell, a-priori, who is right and who is wrong for a specific set of circumstances whose resolution and outcomes are yet ahead of us.”

There. Got that?

What they're trying to say, sort of, is that at some point the consequences of failing are so horrible that “probably won't happen” is no longer good enough for some people. This is an ongoing struggle in financial planning with the “probabilities” group arguing that you can invest in stocks and you probably won't go broke and the “safety first” group countering that you should first make sure that nothing really bad is going to happen and invest what's left over in stocks.

Note that neither group says that you can't lose a whole lot of money. One side merely argues that you probably won't. The other side agrees but argues that “probably” isn't good enough when it comes to losing your standard of living in old age.

I lean toward the safety-first school. My tendency is to first take the unacceptable outcomes off the table and as I mentioned, I consider losing my home an unacceptable outcome.

I'm not against people taking financial risk in retirement. Given the difficulty involved in funding a retirement with our current system, there is no risk-free way to achieve it. I'm only against people taking risks they don't understand.

I've talked with many people who lost their homes or fortunes and not one was able to say, "I understood the risks when I took them and, if I had it to do over, I would make the same bet."

My former neighbor was a business school graduate and he could probably explain the details of his mortgage and his foreclosure risks. I'm just not sure he ever internalized that risk until it was too late.

My point isn't specifically about mortgages, or stock investments, or when to combine the two. It's about risk, both its probability and magnitude. Don't dismiss a potentially catastrophic outcome because the probability of it happening is very low.

You might go broke with a systematic withdrawals strategy, but you probably won't.

You might lose your home if you take a large mortgage and invest it in stocks, but you probably won't.

You could come up short if you claim Social Security benefits early and live to 90, but you probably won't.

The question you have to answer is when “probably won't” is good enough for you.

Retirement Advice for People Who Aren't Rich

I write a retirement finance blog primarily to help people who don't have enough money to attract the interest of a good financial planner. (Hence, the tag line above.)

In reality, retirement planners are effective for a relatively small group of people who have enough money to be profitable for their planners but not so much that they don't need a retirement planner. Bill Gates doesn't need a retirement plan (though he certainly needs tax plans, estate plans, insurance plans, etc.) and households with no retirement savings probably won't find good, inexpensive planning help — except for my blog, of course!

There are ways that people who couldn't save enough money for retirement can improve their situations, by postponing Social Security benefits as long as they can work, for example, and I try to cover those in my blog.

Ron Lieber wrote a column in the New York Times entitled Retirement Advice for People Who Aren't Rich identifying some new services that may also provide retirement planning help for the "unwealthy". Betterment, Wealthfront, WiseBanyan and LearnVest are such services. Though they are all young and unproven companies, they sound interesting enough to consider.

A big caveat here, I have not vetted or used any of these services, so I can only recommend that you research them. I cannot recommend that you actually use them, though I will try them out in the near future. No one knows if these companies will flourish or fail.

The company I feel much better about is Vanguard. I am a longtime Vanguard customer. I love the company and its investment offerings. (I thoroughly dislike their banking services, however, and recommend you consider Charles Schwab if you are looking for a top quality investment company with outstanding and inexpensive banking services. I love Schwab Bank.)

According to Lieber, "Vanguard’s full-service offering, called Personal Advisor Services, costs 0.3 percent annually of the assets it’s managing. For now, customers need $100,000 in accounts there to join, but the company plans to drop the minimum to $50,000 at some point soon. An existing Vanguard service that resembles the new one costs 0.7 percent annually on the first $1 million and requires at least $500,000 on balance."

Vanguard is certainly not a start-up, and their entry into this market suggests that the smaller companies are on to something.

If you have any experience with any of these companies, or similar services, I'm sure my readers would love to hear from you.

The Chicken and the Pig

In the mid-nineties, I began an intensive study of retirement finances. I wanted to retire early. The Tech Bubble was just getting into full swing and dollar signs were flashing before me, none so brightly as the largest "terminal portfolio values" generated by Monte Carlo simulations of safe withdrawal rate strategies.

You know those best of the best-case scenarios where you retire with a million bucks, fund 30 years of retirement, spend $45,000 a year and then leave your kids a portfolio worth nearly eight mil? Never mind that those numbers are inflated dollars 30 years in the future or that they happen once in a blue moon. In the late nineties, everyone with a sock puppet was going to be rich.

I couldn't figure out exactly how that was going to work, so I built my own Monte Carlo simulator to learn the details. (I started my career as a software developer.) Then I really couldn't understand how that was going to work. Constant dollar withdrawals just made no sense to me but, hey, Money magazine was on board so there had to be something there.

(I think today, particularly after the Great Recession, most people have abandoned the constant dollar withdrawal folly and realize that they can spend more when their stock portfolio grows, but they will have to spend less if it shrinks.)

I was a big fan of systematic withdrawal (SW) strategies back then.

Then something happened in my life that caused the financial equivalent of a paradigm shift. You know "paradigm shifts" in science, right? Like when Copernicus explained that the earth revolves around the sun and not the opposite and everyone was like, "Whoa, Dude! This changes everything!"

I had one of those.

I retired.

When my mother-in-law retired from teaching she had said, "You can't imagine what it feels like to realize that you will never receive another paycheck."

I finally understood. Then I looked at my retirement savings and realized that I would also no longer contribute more earnings to that pile of money and, in fact, I would be spending from it every year. In effect, I would be swimming against the portfolio growth tide. When the market gave me 8%, I would be spending half of that, not contributing another 4% of my paycheck.

I had to make that money last an awfully long time to support my family. Three decades, maybe.

Suddenly, "There's a 90% to 95% chance that your portfolio will last 30 years" started to sound more like "there's a 5% to 10% chance that you'll go broke before you die".

Bam! Paradigm shift.

I could stop the story here with ". . . and that's how I became a safety-first guy", except that isn't the end of the story and I'm not a diehard safety-first guy. (But, I'm close.)

The sudden scarcity of paychecks after retiring wasn't the only shock. In 2000, a friend who was heavily invested in tech stocks lost his entire $4M nest egg just a few years before retiring. Literally dozens of my coworkers who held on to their company stock too long lost millions in paper profits that year and likely will never be even paper millionaires again. And those were just the people I knew. At just one of the tech companies.

Having a secure source of money to at least meet my non-discretionary spending needs began to sound pretty important.

Retirement funding is far more complex than systematic withdrawals versus floor-and-upside. Many factors come into play in selecting a strategy. Like, how much wealth you have.

A few of my former colleagues and Tech Bubble survivors escaped the carnage with tens or even hundreds of millions of dollars. They don't much need retirement plans. They can build a diversified portfolio and be pretty sure that even their grandchildren won't need a plan.

More than 90% of Americans, though, have not been able to save nearly enough for retirement. They probably shouldn't be risking anything in the stock market. Other factors that play into strategy selection include whether or not you are married and whether you have heirs. Your health is a factor. It isn't simply a matter of your risk tolerance.

I view retirement strategies as a continuous spectrum from life annuities and certificates of deposit (my mother-in-law's preferred investment) on the conservative end of the spectrum to systematic withdrawals on the riskier end. You can choose fairly precisely how much safety you want at the appropriate point along that spectrum. As a financial planner, I think my job is to place clients at the right point along that spectrum depending on their unique, current financial situations.

Sometimes, things will happen as we age to suggest moving that point along the spectrum in one direction or the other. Pulling the trigger on retirement may be one of those times. It may, as my mother-in-law tried to explain, significantly change how you view the world.

There's a fable about a chicken, a pig and a plate of ham and eggs. The chicken is involved but the pig is committed.

Most people seem like chickens to me before they retire. I was. Same goes for retirement planners who are still working. Chickens think more about spending than risk. When we retire, risk takes center stage.

Retirees are committed.

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