9 Steps to Financial Freedom (Step 8)

No tricks, no gambles, no far-out ideas. Just nine tried and true, simple but not easy steps to financial freedom for Americans abroad. While I originally wrote this for teachers, the basic financial tenets are suitable for every US expat nonprofit worker, missionary, or limited-income worker. I hope you will benefit from it and take the next step. So, without further ado, here is…

Step #8 Allocate assets appropriately

The general rule of thumb suggests that your investments should comprise of stock and bond market money. A bond is a loan that you make to a corporation or a government and they pay you annual interest on that loan. Government loans are the safest. Bonds don’t fluctuate in value the way stocks do, and they’re a solid, more predictable component of a well-diversified portfolio. If you prefer bank CDs to bonds, that’s fine. Just recognize that only $100,000 worth of a bank CD will be insured by the government. If you invest more than that in an individual CD, you could be taking on more risk.

As we get older, we want a higher level of predictability with our investments. Once you’re retired, you won’t want the value of your nest egg swinging wildly with 100% exposure to the stock markets. Professor Malkiel, of Princeton University, suggests that investors should have a government bond exposure that roughly equates to their age. For instance, a 30 year old would have 20-30% of her money in government bonds, while a 60 year old would have 50-60% of her money in bonds (Burton G. Malkiel, A Random Walk Down Wall Street, New York, NY: Norton & Company Inc., 2003, pp. 350-351). This is a generally accepted principle of responsible portfolio allocation—adding further stability as the person nears—or is in—retirement. Some investors might find this method too conservative, but they might want to question whether the added risk of not adding bond is worth taking. And they might also want to examine how much better a risky portfolio (100% stocks) would be over time.

As we get older, we want a higher level of predictability with our investments.

If you had invested your portfolio 100% in a U.S. stock market index from 1973 until 2004, without a single bond index or bond fund, your annual return would have averaged 11.19% per year. And if you had invested 60% of your money in stocks, and 40% in bonds, you would have averaged 10.49% per year. Overall, you would have been rewarded for taking on more risk, with the 100% exposure to stocks, but is a 0.7% annual advantage really worth it? You can be your own judge of that.

As of August 14, 2009, a balanced portfolio of stocks and bonds (Vanguard’s 2020 retirement fund, for example) has dropped just 9.1%. And a 100% exposure to the stock market would be done a whopping 20% over the same time period. It’s up to you.

A quick check on the American Funds website www. americanfunds.com reveals that their average U.S. based fund dropped more than 30% from May 31, 2008 to May 31, 2009. When you’re down 30%, you have to gain 43% just to break even (it’s interesting math) If you’re down 50% in one year, you have to gain 100% the following year, just to break even. If you were 55 years old, and hoping to retire in a handful of years, losing 30% could be devastating.

But if you were 55 years old, and had only 45% of your money exposed to the U.S. stock market instead, you would only have been down about 12% during the same one year time period. You’d only have to gain 13.6% to break even. You’d have your back against the lamppost, but you’d be fully clothed, and your feet would still be on the ground.

If you’re still comfortable taking higher risks for only slightly higher return potential, you might consider this: the U.S. markets didn’t move from 1965 until 1982. For 17 years, the stock market didn’t appreciate (note-dividends would have roughly kept pace with inflation). If that happens again, after a retiree or near-retiree loses 25% to 30% of their portfolio, they’re going to be hurting when they need that portfolio to cover living expenses.

When we’re young, we can afford to take greater risks with our money, exposing more of it to the vicissitudes of the market, but when we’re older, we require more stability and predictability as we rely on withdrawing funds from our retirement portfolio.

This post was originally the chapter “The International Teacher’s Nine Steps to Financial Freedom” in the book Reviving, Retooling and Retiring for Teachers (published by Michigan State University). It was graciously reposted here by Andrew Hallam, public speaker, author of Millionaire Expat: How To Build Wealth Living Overseas, and webmaster of andrewhallam.com where this post also appears. The word “teacher” was sometimes replaced with “US expat.”  

Andrew Hallam

Andrew Hallam

I’m the author of the best-selling personal finance book, Millionaire Teacher—The Nine Rules of Wealth You Should Have Learned in School (Wiley 2011, 2nd Ed. 2017) and The Global Expatriate’s Guide To Investing – From Millionaire Teacher to Millionaire Expat (Wiley, 2015). My website can be found at https://andrewhallam.com/.

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