“Human capital” is the ability to make money by supplying your labor, skills and knowledge. A rough measure of human capital is your expected remaining lifetime earnings. For example: if you continue working for forty years at an average annual salary of $50,000 your human capital is $2 million. Human capital helps determine the suitable amount of “investment risk” for your age. Losses from risky investments early in your working career are small compared to your human capital, plus there is time to recover from an investment setback. When your working years end your human capital is small, earned income has ended and time to recoup losses is less. Investment risks may be taboo!

Many retirees have won “the retirement game” by saving enough, but they continue to risk their retirement by owning risky investments. If you’ve already won the retirement game, why risk losing it? Snatching defeat from the jaws of victory is not smart! Yes, risky investments might pay off and you might hit it big; however, bad luck, the wrong investment or a market meltdown could result in pushing a shopping cart or doing without some basics. If you’ve won at retirement, why continue taking risks?

Financial planners counsel those preparing for retirement to set aside, in safe places, enough money to pay for thirty years of income shortfall. Let’s say your Social Security and other “for sure” retirement income will be $40,000 annually, but you’ve estimated your retirement lifestyle to cost $50,000. This $10,000 annual shortfall times 30 years is what must be risk-free to safeguard your retirement. Retirement planning is complicated by inflation, taxes, interest rates & other surprises and that’s why professional help is needed. Once you and your financial advisor (yes, you need one) have done the arithmetic for your retirement, you’ll conclude one of three things: (1) you’re short and need to increase your savings rate, work longer or change your retirement plans; (2) you have more money than required and some investment risks are okay; (3) you have only the required amount and must protect it. Always err on the conservative side, but if you’ve clearly won at retirement, stop taking investment risks – it’s that simple.

Dave Vick’s “ABC’s of Conservative Investing” is an excellent retirement strategy. Here’s how it works. First, pretend all your money is 100% liquid and you can invest it as you wish. Divide your money into three colors: yellow, red and green. Yellow should be readily available without loss, red can be at risk and green must be safe because it’s your core retirement money. How much is needed in each color depends on your circumstances, tolerance for risks and many other things, but you need some money in each color. The best color combination is determined by working with a financial professional who understands all available options. Managing retirement money is difficult; nonetheless, some retirees try but oftentimes with regrettable results.

When your working years have ended your retirement money cannot be replaced because your human capital is gone, you’ll have little, if any, money from earnings and time to recover losses is growing short. If you’ve saved enough and won the “retirement game”, stop playing the “investment game” by taking risks that could make you a “retirement loser”.

Shelby J. Smith, Ph.D.
October 2012

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