Hedging a fixed retirement

[Falconer]

I am planning on retiring this October and I expect to get $2000 a month from a defined benefit plan that is not adjusted for inflation. I'm looking for a way to hedge this against the ravages of inflation (so I don't take a 4-8% "paycut" each year).

I thought about taking out a 7% mortgage (where the mortgage rate is fixed for the next 30 years), the mortgage would cost $2000 a month so the retirement check would cover it for 30 years. I would then invest the borrowed money. Unfortunately I don't come out ahead using this strategy for 10 years (assuming 7% inflation), with a breakeven point at about 20 years (not very efficient).

Any ideas?

Thanks,
Elvis

 

[Rich_by_the_Bay]

Not sure what you mean by "hedging" but the only sensible way I know to offset the erosion caused by inflation is to invest in a well-diversified stock portfolio.

Without knowing what other assets you have or what your expenses are, I hope that after the $2000 per month you have enough to invest to generate the difference at a safe withdrawal rate of 4% or so.

Mortgage? Doesn't sound like a winning strategy to me unless you can and will invest the cash freed up by the loan at a substantial returns -- hardly a safe bet.

Otherwise, to live forever on $2k/month, get ready to live on half of that and invest the difference.

I'm sure if you provide more detail, the group will offer their opinions.

 

[heyyou]

When Scott Burns covered this topic, he recommended a well diversified portfolio including:
a) slightly higher equity allocation
b) some inflation indexed bonds in bond portfolio
c) sliver of commodities fund since most sudden inflation is commodities related
d) some energy/oil fund investment since he believes that is the new gold of the 21st century

He quoted a study that stated there are various types of inflation. each with a different hedge.  Energy cost inflation is different from falling dollar inflation.

He also said that $200 a week from part-time work at WalMart is the income equivilant of an extra $250,000 in your portfolio.

 

[rmark]

Hebeler suggests a simplified formula of multiplying a fixed pension payment x age as a percentage, spending part and reinvesting the rest. So at age 65, spend 65% and invest the rest.

 

[donheff]

Hebeler suggests a simplified formula of multiplying a fixed pension payment x age as a percentage, spending part and reinvesting the rest. So at age 65, spend 65% and invest the rest.

So when do you start spending the portion you invest? Or do you just calculate the impact of inflation on the fixed amount by inflation and take that amount from your "investment?"

 

[Cransten]

Falconer, that's a very creative idea, but has considerable risk.  Your investment returns may fall short of your expectations; your house could fall in value. 

Without knowing more of your financial situation it strikes me that you have far too much in your house if all you have is that and your pension.  If that's the case, sell your house, and keep the sale proceeds invested, and live off your pension.  Alternatively, sell your house, and buy cheaper digs (perhaps in a different housing market) and reinvest the difference.

As for what to invest in, that's another topic, but you can be as diversified as you like once you've freed up the capital you have in your home, and be prepared for multiple scenarios. 

 

[Falconer]

Hebeler suggests a simplified formula of multiplying a fixed pension payment x age as a percentage, spending part and reinvesting the rest. So at age 65, spend 65% and invest the rest.

That sounds like the ticket.  Typically one would plan on 7% returns. Save half of the annuity.  Spend 4% of the returns on the saved portion and leave 3% for inflation. The 4% that you spend covers inflation for the annuity for the year and the 3% you save covers the inflation on the savings which will allow you to cover inflation next year. 4/7's is close to 57%, the amount you should spend at age 57 according to Hebeler, so his formula does make sense.

I do have other assets, I just wanted to figure out a way to cover this fixed annuity so 20 years from now it would be worth more than a case of beer each month.

Thanks for the responses,
Falconer

 

[brewer12345]

Buy some commodities. Historically, they are high return (like equities) and have been highly negatively cotrrelated with long duratin fixed bond returns. A perfect match, assuming the past is a good guide to the future.