If you had a choice, would you rather lose a third of your money when you're 60 years old or 75? Now don't worry. I know you don't want to lose your money at any time. I've written this book in order to help you avoid losses, but stay with me for a minute. If you had to lose a big chunk of change, do you think you'd be better off losing it when you first retired or 15 years later?
I suspect many of you will lean toward losing it right away instead of later. You think, “Wow, it'd be really scary to lose a third of my investments when I'm 75. I might have medical bills, and it would certainly be hard for me to go back to work.” All true. It would be scary, and you would have a hard time recouping your losses. But in terms of your investments, you've made the wrong choice.
If you lose a third of your money when you're 75, it's still possible you could live the rest of your years on the remaining two-thirds of your investments and be just fine. To put it a bit bluntly, the older you get, the less work your money has to do because your life expectancy isn't that long.
The younger you are, the longer your life expectancy. Your money has to do more heavy lifting, because it needs to carry you for the rest of your life.
That's a serious issue, but it's not the only problem with losing money early in your retirement. You invest with the idea that you'll make money over time. If you lose a third of your money when you're 60, you haven't just lost that money, you've lost its time value. You'll miss out on all the income your money could have generated and all the potential gains you might have had in the next 15 to 20 years. That's a substantial amount of cash.
Albert Einstein is reputed to have said that compound interest is the eighth wonder of the world. And it's true—compound interest is amazing. You know how it works: You invest a sum of money, earn interest, and then reinvest the interest earned back into your original investment. Let's say you invest a million dollars (that's my favorite number—you'll notice I use it a lot), and you earn 5 percent interest yearly on that initial investment. After your first year, you'll have earned $50,000, so your new principal is $1,050,000. Now you invest all that money and earn 5 percent. By the end of the second year (assuming 5 percent interest), you'll have $1,102,500. If you continue to reinvest the interest you've earned, by year five you'll have $1,276,281. After 10 years, you'll have $1,628,894, and after 20 years you'll have $2,653,297. Even though you earned just 5 percent interest, you more than doubled your money in 20 years! See why compound interest feels like the eighth wonder of the world?
If you lose money up front, you have lost all potential for compound interest, for growth going forward on that money. I've dubbed this negative process “reverse compounding.” It works on the same time-dependent principals as compound interest, but has the opposite effect. This concept is easiest to explain by looking at the math, so I've created a couple of charts for you: Tables 4.1 and 4.2. Both of these charts assume that you retire with a million dollars, that you get a return of 5 percent each year, and that you take out 4 percent of your investments in the first year for living expenses. These examples also assume that your living expenses grow by 3.5 percent each year after the first year due to inflation, and that at one point during your retirement you experience a bear market.
Table 4.1 Losing 37 Percent in Year 15
| Year of Retirement | Balance at Beginning of Year | Investment Gain/Loss for the Year | Withdrawal for Cost of Living | Total Gain/Loss | Balance at End of Year |
| 1 | 1,000,000 | 50,000 | 40,000 | 10,000 | 1,010,000 |
| 2 | 1,010,000 | 50,500 | 41,400 | 9,100 | 1,019,100 |
| 3 | 1,019,100 | 50,955 | 42,849 | 8,106 | 1,027,206 |
| 4 | 1,027,206 | 51,360 | 44,349 | 7,012 | 1,034,218 |
| 5 | 1,034,218 | 51,711 | 45,901 | 5,810 | 1,040,028 |
| 6 | 1,040,028 | 52,001 | 47,507 | 4,494 | 1,044,521 |
| 7 | 1,044,521 | 52,226 | 49,170 | 3,056 | 1,047,577 |
| 8 | 1,047,577 | 52,379 | 50,891 | 1,488 | 1,049,065 |
| 9 | 1,049,065 | 52,453 | 52,672 | (219) | 1,048,846 |
| 10 | 1,048,846 | 52,442 | 54,516 | (2,074) | 1,046,772 |
| 11 | 1,046,772 | 52,339 | 56,424 | (4,085) | 1,042,687 |
| 12 | 1,042,687 | 52,134 | 58,399 | (6,264) | 1,036,423 |
| 13 | 1,036,423 | 51,821 | 60,443 | (8,622) | 1,027,801 |
| 14 | 1,027,801 | 51,390 | 62,558 | (11,168) | 1,016,633 |
| 15 | 1,016,633 | (376,154) | 64,748 | (440,902) | 575,731 |
| 16 | 575,731 | 28,787 | 67,014 | (38,227) | 537,503 |
| 17 | 537,503 | 26,875 | 69,359 | (42,484) | 495,019 |
| 18 | 495,019 | 24,751 | 71,787 | (47,036) | 447,983 |
Table 4.2 Losing 37 Percent in the First Year
| Year of Retirement | Balance at Beginning of Year | Investment Gain/Loss for the Year | Withdrawal for Cost of Living | Total Gain/Loss | Balance at End of Year |
| 1 | 1,000,000 | (370,000) | 40,000 | (410,000) | 590,000 |
| 2 | 590,000 | 29,500 | 41,400 | (11,900) | 578,100 |
| 3 | 578,100 | 28,905 | 42,849 | (13,944) | 564,156 |
| 4 | 564,156 | 28 208 | 44,349 | (16,141) | 548,015 |
| 5 | 548,015 | 27,401 | 45,901 | (18,500) | 529,515 |
| 6 | 529,515 | 26,476 | 47,507 | (21,032) | 508,483 |
| 7 | 508,483 | 25,424 | 49,170 | (23,746) | 484,737 |
| 8 | 484,737 | 24,237 | 50,891 | (26,654) | 458,083 |
| 9 | 458,083 | 22,904 | 52,672 | (29,768) | 428,315 |
| 10 | 428,315 | 21,416 | 54,516 | (33,100) | 395,214 |
| 11 | 395,214 | 19,761 | 56,424 | (36,663) | 358,551 |
| 12 | 358,551 | 17,928 | 58,399 | (40,471) | 318,080 |
| 13 | 318,080 | 15,904 | 60,443 | (44,539) | 273,541 |
| 14 | 273, 541 | 13,677 | 62,558 | (48 881) | 224,660 |
| 15 | 224,660 | 11,233 | 64,748 | (53,515) | 171,145 |
| 16 | 171,145 | 8,577 | 67,014 | (58,547) | 112,689 |
| 17 | 112,689 | 5,634 | 69,359 | (63,725) | 48,964 |
| 18 | 48,964 | 2,448 | 71,787 | (69,339) | — |
Table 4.1 illustrates what happens when a bear market occurs 15 years into your retirement. The average bear market incurs a loss of 37 percent, so we'll assume that was your loss (by the way, bear markets can cost you even more—in 2008, you could have lost up to 57 percent). In this example, even though your investments took a bad hit, you can see that at the end of your 18th year, you still have $447,983.
But look at Table 4.2 to see what happens if you get hit with a bear market right off the bat.
You run out of money in 18 years! You can see why it is so important to protect your money from large losses, especially in the early years.
I want you to have money when you're old. In order to have—and keep—your money, you need to understand this fact: the five years before you retire and the five years after you retire are the most important years of your entire financial life. As you can see from the examples I provided, if you lose mass quantities of your money during those years, you severely impair, if not completely destroy, your money's ability to support the lifestyle you want.
But why these particular 10 years? You can probably see why the five years before you retire are important. If you suddenly lose a fourth or half of your investments, you'll have two choices: retire later than you'd planned, or live a different retirement lifestyle.
If you experience a big loss during the first five years after your retirement, you're faced with even more difficult choices: either change your lifestyle dramatically, or go back to work. The second choice could be a problem. Your skills may have atrophied. Your old company may have hired somebody else for your position. You'd probably have to compete against younger people. It can become very difficult to replace the income you've now lost.
Though the examples I've provided are hypothetical, the chance of a bear market in your lifetime is not. They tend to occur every three years, remember? You could lose a substantial amount of your retirement if you hold on to your investments during a bear market.
When you were young, you might have been able to recoup from a big loss. Once you're over 50, you're in a different game. You need to preserve as much of your net worth as you can. You need a different strategy, one that mitigates the downside of longevity and helps you withstand bear markets. You need to break free of the buy-hold mindset, or you might end up like the unlucky lady described in the next chapter.