For Retirees It’s About Your Income, Not Your Wealth

Driven by the belief that a larger nest egg will provide more monthly income, retirees typically seek to enter retirement with as large a savings balance as possible. At some level, that assumption makes perfect sense. A retiree should logically presume that a larger amount of savings will generate more income to meet living expenses. But it often doesn’t work out this way. This is because of a financial reality that is important for all retirees to understand: In retirement, it’s your income, not your wealth, which creates your standard of living.

The reason this fact deserves your careful attention is because the income-producing value of money changes all the time. You should assume that while you are retired it will change- maybe a lot. And the financial implications of such changes can be profoundly troubling. Why? Because no retiree stops needing income! Never, ever.

An Example: The Income-Producing Value of Money Changes Over Time

Too often, I believe, retirees fail to grasp how their ability to meet expenses in retirement can be subject to forces beyond their control. I will use the following example to explain how the income producing value of money changes over time. Imagine a retiree who has accumulated a nest egg of $500,000. The $500,000 is owned by an individual who has little appetite for risk. Back in 2000, this retiree could have purchased six-month CDs and earned interest of 6.91%. That would have provided the retiree a monthly income of $2,878.

Now, fast forward to 2014. The very same $500,000 would have earned an interest rate of only 0.28% and generated a monthly income of $116! Consider carefully this incredible change in the ability of wealth- the retiree’s $500,000- to produce monthly income. Same wealth, but 96% less income!

What about more recently? Well. A tough situation gets even tougher. The average CD rate in August 2021 was just 0.09%. That’s only $38 per month!

The hard-to-fathom but quite real decline in interest rates has caused many retirees to turn to more risky investments in order to earn better returns. And thus far it’s worked well. The stock market has been up for eleven years. That is absolutely unprecedented. But should retirees count on a continuation of increasing stock prices?

Creditism Drives the Economy

Consider this question: Is the U.S. economy still based upon capitalism? The economist, Richard Duncan, doesn’t think so. Duncan states that we have entered into a new system he calls creditism. Under creditism, economic growth is a direct function of credit growth. Duncan has shown the relationship between credit growth in the US economy and appreciating stock prices. He has pointed out that since 1952, the U.S, has experienced nine recessions. Each of these recessions coincided with a period when inflation-adjusted credit growth fell below 2%. It seems that 2% is the magic number. When credit grows by 2% or more in real terms, asset prices have appreciated. When it falls below 2%, we enter recession.

Retirees should be cognizant of this fact, and they should keep a sharp eye on credit. Since 1964, total credit in the U.S. has grown at a breathless pace. Back in 1964, total credit in the U.S. equaled $1 trillion. As of Q2 2021, it reached $85 trillion! Since the market breakdown in 2008, it is government debt that has increased the most, from $6.2 trillion to $22.9 trillion as of Q3 2020. The dramatic rise in total credit has served to drive up asset prices, including real estate and stocks. The government has funded this credit growth through the Federal Reserve’s policy of Quantitative Easing. As a result, household wealth has skyrocketed, increasing from $60 trillion in 2009 to $124 trillion as of last year. It is even higher now.

Will it continue in this fashion? Will retirees continue to enjoy appreciating wealth as a result of continuing increases in stock prices? Maybe not.

The Federal Reserve publishes an index which tracks Household Net Worth as a Percentage of Disposable Personal Income. This index is sending us a danger signal which retirees should be aware of. In 2000, just before the NASDAQ bubble burst, the index level reached a then all-time high of 615. In 2008, just before the real estate bubble burst, the index again rose to an all-time high of 669. Today, the index level is at a new all-time high of 786.

Retirees should ask themselves some key questions:

1. Do I believe that the government will be able to expand credit beyond the stratospheric levels we have already reached? (At $85 trillion, the base is now so massive, a 2% real increase in credit e.g., 3% inflation plus 2% means that total credit must grow by 5% in order to keep asset prices rising. This means adding another $4.25 trillion in debt!)
2. Am I prepared for possible significant declines in stock prices? And do I understand the implications for my ability to generate monthly income?
3. Do I have a strategy for generating income should I move savings to lower risk investments?

My advice to retirees is to be alert and take nothing for granted in terms of the future performance of stocks. This is a good time to reach out to a financial adviser who specializes in retirement income planning.