MONEY Master the Game: 7 Simple Steps to Financial Freedom (48 page)

5. 
Your Pension.
Got one? This bucket is the place to keep it if you’re one of the lucky few. Remember the example of Dr. Alicia Munnell, director of the Center of Retirement Research at Boston College? She liquidated her pension and took an early payout, thinking she could invest and get a higher return than her past employer, the Federal Reserve. She learned the hard way that you don’t want to risk your lifetime income plan, and now she shares her story as a warning to others.

6. 
Annuities.
If you’re young, and you hear this word, you may think this doesn’t have any value for you. In the past, they took a lot of money, and you
had to be a certain age in order to tap into these investment tools. But as you’ll learn in chapter 5.3, “Freedom: Creating Your Lifetime Income Plan,” there are some new tools you can arm yourself with. Remember, these investments are insurance products that can give you a
guaranteed income for life. They’re like private pensions if they’re done right.
But as we’ve discussed, most annuities out there are terrible investments with high fees and ridiculous penalties. Most variable annuities should come with more warnings than a Viagra commercial! But you can find a few select annuities—which you will learn about in section 5—that are so safe and affordable that many experts call them the Holy Grail of retirement income solutions. How’s that?
They can give the kind of returns you enjoy in your Risk/Growth Bucket within the safety of your Security Bucket. A guaranteed income that will last your lifetime and never go down in value!

7. 
At least one life insurance policy belongs in your Security Bucket, and you don’t mess with it.
Why? Got a family? If you die, your family will be taken care of. Term life will suffice for most people. However, another type of life insurance policy,
described in section 5, can provide you with
an income for life, tax free, while you’re still alive!
And if structured correctly, it can also provide enormous tax efficiency. The largest corporations and the ultrawealthy have been using this IRS-sanctioned approach for decades. Be sure to check out chapter 5.5 for details on how to use this tool to perhaps cut the time it takes to get to your financial goals by 25% to 50% depending on your tax bracket.

8. 
Structured Notes.
These products have been called “engineered safety” for investors. Structured notes are like market-linked CDs, but they aren’t covered by FDIC insurance. How do they work? You lend money to a bank—usually one of the biggest banks in the world—and the bank promises to give you back the money after a specified period of time,
plus
a percentage of whatever gains accumulate in a particular index (say, the S&P 500—minus the dividends—commodities, gold, REITs, or a combination). For example, at the time of this writing,
J.P. Morgan has a seven-year structured note with 100% downside protection, meaning you’ll never lose your original investment, plus it gives you 90% of the upside gain of the S&P 500.
No wonder, as you learned in chapter 2.8, the ultrawealthy often use this tool to invest.
The right kind of structured note can be a great way to participate in the upside of the market without worrying about the downside—especially at a stage of life when you can’t afford to take such volatility risks.

When I sat down with
Mary Callahan Erdoes, CEO of J.P. Morgan Asset Management,
with $2.5 trillion under management, she told me structured notes can be good investment choices, particularly for people afraid to put their money in
anything
after the financial meltdown of 2008. And they’re
not
a gimmick. “A lot of times, people will look at a structured note and say, ‘That looks too good to be true,’ ” she told me. “But you need to understand the product from start to finish.
There are no gimmicks, there are no gadgets; it’s just math in the markets . . . The longer you don’t need liquidity, the more the market will pay you for that.
If you’re going to put your money away for seven years, you should be able to get that much upside.”

So do structured notes belong in
your
Security Bucket? The structured note is only as secure as the bank that issues it. Erdoes made it clear that J.P. Morgan was the largest bank in the world. Some fiduciaries will recommend the Royal Bank of Canada or other Canadian banks, since they have been rated as some of the best and safest in the world. (The United States saw more than 9,400 banks collapse during the Great Depression and almost 500 in the recent Great Recession.
Not one bank failed in Canada!
) So, as always, you have to weigh the benefits against the risk and make your own decision. Also, watch out for fees and complicated contracts. As we said in chapter 2.8, structured notes can be a terrible product, just like mutual funds, if there are too many fees attached. If the issuer is fiscally strong, you won’t lose your money. But if the timing is off, you won’t make any money in that time period. So this is more of a secure protection strategy. It’s best to talk over this investment with your fiduciary advisor before jumping in.

TIME IS ON YOUR SIDE

Whew! That was a lot. But remember, if your head is exploding with all these choices, you’re not in this alone. You can have your complimentary asset allocation (and full portfolio review) done for you online at
www.strongholdfinancial.com
or by your own fiduciary advisor.

But it’s important to understand the concept of asset allocation and which investments are available for each of these buckets so that your overall portfolio—your group of investments—reflects your goals and level of risk tolerance. That way you’re still running the show! At every decision point, you’ll be thinking, “How much am I risking and how much am I keeping secure?” That’s where the game is won or lost!

And, as you’ve already seen, the biggest challenge for your Security Bucket today is:
What is really secure?
We know the world has changed, and even conservative savers have been forced into riskier and riskier investments by crazy-low interest rates. It’s tempting to shoot for bigger returns, especially when the stock market is galloping. You may start thinking, “I’ll never get where I need to go from here.” But you can if you’re willing to play the long game. (And especially if you find some investments that guarantee returns without risking principal—which you’ll learn about soon.)

Just like in that old Rolling Stones song, time is on your side when it comes to growing your wealth. And time is certainly the greatest asset for the Security Bucket—even if you start later in life. After all, more and more of us are living into our 80s and 90s, so our investments can mature along with us. And if you’re Generation X, Y, or Z—yes, there is a Generation Z, the postmillennials!—you’re way ahead of the game! You can start with a tiny amount and let the magic of compounding get you where you want to go so much easier.

What happens to the money in your Security Bucket reminds me of an old gambler’s trick on the golf course. The gambler tells his mark, “You play golf? I just started playing, and I’m no good. You want to play ten cents a hole?” So the guy says, “Sure, great!” On the way to the first hole, the gambler says, “You know, ten cents is kind of boring. Just to make it more fun, why don’t we just double the bet every hole?” The first hole is 10 cents, the second hole is 20 cents, the third hole is 40. By the time they get to the fifth hole, it’s $1.60. The sixth hole is $3.20, and they’re only one-third of the way through 18 holes. By the time they get to the 18th hole, how much are they playing for? How about $13,107! That’s a steep golf bet, even for Donald Trump. And that’s the magic of compounding in action.

It’s also what happens when you’re investing in your Security Bucket over the long haul. You reinvest the interest you make, and, for a long time,
there seems to be no progress at all. But you get to the 13th hole, and then the 14th, and then the 16th, and then it explodes. Take a look at the chart on
page 312
. That’s the exponential progression that will work for you.

Of course, sitting tight is a challenge for this generation! As a society, we’re wired for instant rewards, and waiting for the assets in our Security Bucket to increase in value can initially feel like watching grass grow. And that’s why we get tempted into putting too much of our money into the next bucket, Risk/Growth. But not everything in your Security Bucket has to be dull as dishwater. If you have a talented and connected fiduciary advisor, he or she can show you how to take some of these boring security tools and eke out a more reasonable return, or even a significant return if you find the right environment.

Here’s just one example of what my Stronghold advisor found for me—and it’s an asset that most people wouldn’t normally put in their Security Bucket: a residential real estate loan!

It starts with a guy building a house in Indian Wells, California, who ran into some financial trouble and had to sell it to a group of investors. Ever hear of Indian Wells? It’s like the Beverly Hills of Palm Springs, which is one of the highest-income environments per capita in the United States. The city is beautiful, with extraordinary weather, surrounded by golf courses and resorts—an amazing place to own a home or a vacation home. The investment company that bought the guy’s house buys up dozens of properties, so it needs a lot of cash—but the company doesn’t need it for long because it fixes up and resells the houses quickly. To keep the money flowing, the company needs investors to give it short-term loans in exchange for first deeds of trust on the properties it holds.

Ever hear about first trust deeds? If you own a home and have a mortgage, a financial institution loaned you the money to buy your house, and you gave it your bond to pay it back at a certain rate of return. However, if you don’t keep your word and fail to keep up the payments, the entity that owns the mortgage,
or trust deed,
has the right to force you to sell—and it continues to receive interest until a new owner takes over. As an investor, I look for ways to get maximum rewards in a secure environment—a first trust deed structured properly can be perfect for this purpose.

My advisor and I found out that the real estate investment company was
offering the first deed of trust on that house in Indian Wells as collateral on a $1 million loan, which would pay 10% interest for one year. It was willing to have one investor take this on, or as many as 25, each contributing $40,000. In the end, I decided to invest in the full $1 million myself. You might say, “Wow, that’s a great deal! You get a hundred-thousand-dollar profit to tie up your money for just one year. But Tony, what’s your risk?” That’s exactly why we did a lot of research. The home, we learned after two qualified appraisals, was worth $2 million in its current state. So if I’m loaning $1 million, that loan has a 50% loan-to-value ratio, right? Even if the company defaults, my $1 million is secure because the value of the property is $2 million.

This was a pretty great deal, but I’ve also bought deeds of trust on smaller homes. Say I’d found a starter home in the Midwest that was worth $80,000. If I could get the mortgage for $40,000, at 50% loan to value, I might make
the loan. The Indian Wells deal was similar, only on a larger scale. So I decided to go for it, and I put that investment in my Security Bucket.

Okay, I can already hear you saying, “Wait a minute, Tony! What if the market drops? Doesn’t that investment belong in your Risk/Growth Bucket?”

That’s a great question, because we’ve just been through one of the worst real estate crashes in history! And on the surface, it looks like you’d probably put this in your Risk Bucket. But here’s why I think it’s a safe investment: in 2008, when the real estate market just went through the floor, and the world was upside down, the prices of houses in most parts of the United States dropped 30% to 40%, max. There were a few exceptions, such as some parts of Las Vegas, Phoenix, and Miami, where the prices dropped more than 50%. But all of those places had massive price growth right before the bubble burst. The Indian Wells area didn’t experience that size of bubble—and while prices dropped 31% from 2008 to 2010 (far below the 50% mark), the biggest loss in a single year was only 13.6% (from 2008 to 2009). And remember, we’re loaning for only one year. So if residential real estate didn’t take anything close to a 50% hit in Indian Wells in 2008, it’s not likely to happen this year.

That’s why I decided to move forward with this as the investment to put in my Security Bucket.
It’s the place where you have to be cautious.
But it doesn’t have to be totally boring. And sometimes the returns can be very nice (8% to 10%, whereas many people typically settle for 1% to 4% returns in the Security Bucket) if you do your homework!

It is my contention that Aesop was writing for the tortoise market. Hares have no time to read.

—ANITA BROOKNER