Warren Buffett, one of the world’s most successful investors, has two simple rules of investing:
- Never lose your principal.
- See rule number 1.
Unfortunately, during the recent economic downturn, many people have lost some if not most of the principal in their retirement accounts. As a result, either they have to delay their retirement plans and keep working, or they have to find a way to quickly recoup the funds they’ve lost.
But regaining the lost principal takes more work and higher returns than people realize. Here’s a quick riddle that illustrates this point: Do you know when 30 plus 43 equals 0? Here’s how we get to the answer:
Suppose you have invested your retirement money in the stock market, and as a result you lost some of your principal. Your initial principal investment was $100,000, and you have lost $30,000, or 30 percent. What percent of your remaining principal do you need to earn to get back to where you started? Most people say, “30 percent,” but that’s incorrect.
If you started with $100,000 and lost $30,000, you’re down to $70,000. That’s all you have to work with. Multiply $70,000 by 30 percent, and you get $21,000. Add that to your $70,000 remaining principal, and you have $91,000. You’re still $9,000 short of where you started.
To get back to zero — back to your starting point of $100,000 — you actually need a 43 percent return on your $70,000 principal. This is how 30 plus 43 equals 0.
So once you’ve lost some principal, you have to make a higher annual return on your investment, which for most people means riskier and riskier investments. But the more risk you take on, the more money you stand to lose. It’s a vicious cycle that can quickly ruin anyone’s retirement dreams.
If you’re one of the many people who have lost some principal in your investment accounts, here are some suggestions that will help you regain what you lost without so much risk.
Stop Putting Money in the Stock Market
Most people don’t realize how heavily tied their retirement accounts are to the stock market. However, if you’re putting your money into mutual funds of any kind, then you’re investing in the stock market and essentially gambling with your retirement money. And because the stock market is so volatile, it’s a lot like Vegas — easy come, easy go.
Even though your broker may tell you that “now is the time to invest” and that “if you want higher returns you have to take more risk,” don’t listen to him or her. Stop putting your retirement money into any investment that has such a huge possibility of loss. Remember, your broker only earns money or gets paid when you invest money with him or her, so of course “now is the time to invest.” No one is going to willingly reduce their income. So why should you willingly take the chance of reducing your retirement income?
Get Out While You Can
Here’s something your broker will never tell you: In addition to not putting any more money in the stock market, get completely out of the stock market — now. That’s right. Pull your money out, take the penalty hit, and move your remaining principal into safer investments. Sound crazy? It’s not, and doing so could make a significant difference in your future.
In a recent Time magazine article, the outspoken economist, Nobel Prize winner, and New York Times columnist Paul Krugman warns that “the recovery is stalling and we may be in for a dreaded double-dip recession, in which the economy slides back into negative growth after a brief rebound.” In other words, a Nobel Prize-winning economist believes any recovery we may be experiencing now is only temporary, and even more losses are looming. Unless your broker is also a Nobel Prize-winning economist, you may want to reconsider what he or she tells you about investing more money in the stock market. As long as your money is tied to the stock market, your losses can grow quicker than any potential gains. The best bet is to move your money into a safer alternative.
Get Truly Diversified
Mutual funds and other investments tied to the stock market are not your only options for retirement planning. In fact, you have numerous investment choices that have much lower risk and deliver equal if not better returns. Some things to start investigating include:
Life Settlements: A transaction in which an existing life insurance policy that is no longer needed or is in danger of lapsing is offered for sale to institutional investors in the secondary market.
Fixed Index Annuities: An Annuity whose earnings are tied to the performance of a market index or indexes (e.g., the Standard & Poors 500). Fixed Index Annuities are intended for the accumulation phase of retirement savings. The term “FIA” is sometimes used interchangeably with “Equity Index Annuity,” but that’s not always accurate since FIAs may be tied to indexes other than stock market indexes. It’s also known as an Index Annuity.
Whole Life Insurance: A form of life insurance that applies part of the premium payments to build an investment or savings value for the policy owner. The investment or savings value is called the cash surrender value of the policy. Such a policy protects the beneficiary, builds cash value, and can be borrowed against. The premiums can be locked in and guaranteed to remain the same over the life of the policy.
Gold: Of all the precious metals, gold is the most popular as an investment. Investors generally buy gold as a hedge or safe haven against any economic, political, social, or fiat currency crises (including investment market declines, burgeoning national debt, currency failure, inflation, war, and social unrest).
Many brokers call these things “boring” investment options. However, you’re better off investing in “boring” options (like Warren Buffett does) where you minimize your risk and earn a steady return.
If Possible, Up The Ante
If you’re trying to recoup your principal losses, it makes sense that you’d want to contribute more to your retirement savings each month. However, if you decide to stay in a qualified plan through your broker (plans that are typically tied to the stock market), the government limits the amount you can contribute each year. So even if you want to contribute a substantial part of your income to catch up, you can’t. However, when you decide to invest in alternative investment options, there are no limits on how much you can invest. This makes it much easier to recoup your losses and even make a financial gain.
Claim Your Own Recovery
No matter how much you’ve lost in your retirement accounts, don’t get discouraged. Instead, learn from your mistakes and use your new knowledge to make better financial decisions. While not everyone will attain the same investing success as the legendary Warren Buffett, with some good planning and a new outlook on investing, anyone can recoup their principal losses and have a financially secure future.
