Cash-Rich Retirement by Jim Schlagheck, seen on public television’s Retirement Revolution, seeks to turn the retirement advice community on its head by taking “the investing techniques of the mega-wealth” and bringing it to the masses. It’s quite a bold statement to make, since we all know the mega-rich are afforded a much different set of rules than the rest of us, so we’ll see if Mr. Schlagheck can deliver.

The dust jacket says that Schlagheck’s advice “breaks with conventional advice that tells the public to invest mightily in stocks, flip holdings, and seek capital gains.” I’m not sure that the conventional advice says you should be actively trading stocks, but then again personal finance bloggers live in a world where we are exposed to the sage advice of Buffett and Bogle, two accomplished investors who actively advocate index funds for the masses. However, even if you accept the belief that the conventional advice is flipping stocks, Schlagheck advocates investing for “prudent income… Build a ‘life-cycle’ annuity package for lifetime retirement income. Focus on dividend-, interest-, and rent-producing investments and insurance.” If your alarms went off when you red “life-cycle” annuity package, you weren’t alone - mine went crazy. Annuities are actually one of the “six straight-shooting, show-me-the-money steps” in the Cash-Rich Retirement plan. We can see what Schlagheck means when we get to them.

The six steps are:

• Change your “automatic pilot”
• Diversify your holdings in radically different ways
• Build out your investment plan with funds and objective research
• Get all the professional help you can
• Build income streams with a ladder of annuities
• Invest in long-term health care insurance

Setting the stage

The book begins by discussing retirement and how the rules of the game have changed. Schlagheck has a very straight forward and easy to understand writing style and the book is organized in a way that makes it very easy to follow. He makes excellent points about how the retirement is changing, given the changing demographics, solvency of Social Security, and a whole collection of other issues. It really does drive the point home that the old rules of retirement are changing (because they are!).

Let’s see these six steps…

Change your “automatic pilot”

Schlagheck’s term of “automatic pilot” refers to the fact that you concept of “saving for retirement” is investing for speculative gains. It means taking stocks in your Roth and going after high flyers, it means pushing your 401(k) contributions into microcaps or other more risky investments, and he argues that you need to rewire the way you think and act differently. Less like a slot-machine player and more like a saver and cautious investor. Mostly, he’s saying you need to take your retirement seriously right now. What does he recommend you do?

• Save at least 20% pre-tax income
• Hold savings in tax-sheltered accounts (401k, 403b, etc.)
• Automate saving (think, Automatic Millionaire)
• Don’t chase speculative gains

So far, nothing super incredible or only within the realm of the super-rich. It’s just straight up, smart personal finance advice that’s been repeated before, though it does have some eye-opening statistics not often included in other books.

Radically diversify your holdings

This chapter focuses on how your asset allocation is probably off, though it focuses on many of the simple mistakes people may make such as investing too much in company stock or being too risky in allotments. He advocates investing in things that provide cash flow. That includes dividend stocks, interest bearing accounts or investments, and “rent” producing REITS or rental properties. This is probably where the “Cash-Rich” in the title comes from. Another category he says you should increase in is international exposure, an idea that probably would’ve netted you quite a tidy sum had you implemented several years ago.

From here, this book has some nice ideas but nothing that’s radically new or unheard of. Since the annuity chapter sounded some alarms, let us skip to that chapter.

Build income with annuities

Annuities are like timeshares, they’re not inherently bad, they were just pitched by inherently bad people. The book makes an excellent case for annuities and one that I buy into, though, as they say, the devil is in the details. Annuities provide protection against longevity risk, which is the risk that you’ll outlive your retirement savings, by providing a guaranteed constant income stream and Schlagheck recommends using them after everything else (401k, Roth). I believe that to be prudent advice.

Schlagheck explains annuities, how they are structured, the four main types, the benefits, drawbacks, etc. If you want a primer on annuities, Schlagheck has a good one in his book. He warns about the costs of an annuity, which are 2.3% average, and says that there are many excellent ones at a fraction of the cost.

So what’s this life cycle strategy? The idea is that you want to ladder your annuities so that you get different amounts of income at different points of your retirement. His example has three annuities, each paying out for three different time periods. The first pays out income for 9 years from age 65 to 74, #2 pays out for 9 years from 75 to 84, and #3 pays out from 85 and onward. I’m afraid the details are outside my capability to detail with much clarity so you’ll have to check out the book if you want to know how their structured. He also provides a lot of explanation that I think is crucial for understanding how to ladder annuities, such as tax implications, purchase tactics, etc.

Overall Impressions

Overall, I felt Schlagheck did a good job explaining his cash-rich retirement plan, even though I skipped a few of them in this review, though nothing seemed exclusive to the mega-wealthy. Granted, the ability for most retirees to invest in rental properties is slim (but not unheard of) but investing in dividend stocks, buying annuities, and many of the other suggestions are not anything special. His explanation of annuities, for someone who knows little about them or the fact that laddering them would be a good technique, was comprehensive and easy to understand. If you have the basics of retirement down and are looking to learn more, I think getting this book, either at the bookstore or your local library, would be a great first step.

This post comes from Mike of Quest for Four Pillars, “another Canadian Financial Blog,” that traces its namesake to none other than the Four Pillars of Investing by William Bernstein.

In the blogosphere there seems to be a lot of excitement about peer-to-peer lending which is the ability to lend money to other individuals through companies such as Prosper and Lending Club. While I can understand how some investors will always be interested in a new investment product I don’t really understand the widespread excitement and interest level for this one.

Some of the things people should think about when considering P2P lending:

Diversification

Lending to one person is kind of like investing in a very small risky stock such as a junior mining company or a startup biotech company. You really don’t know much about that borrower and if something happens to them such as a medical emergency then your loan to them might be at risk. You can mitigate this risk by lending using a portfolio plan but I suggest that while this does reduce your risk, it doesn’t change the basic asset class which is still quite risky. A portfolio of p2p loans is like a mutual fund with numerous junior mining companies). You reduce the risk of any one company failing but aren’t protected against events that affect all junior mining companies ie falling metal prices.

One of the big risks that I would be concerned about is if interest rates go up. Presumably people who borrow on p2p are people who can’t get the loan from a bank at a normal rate - I would assume these people have already maxed out their credit or at a minimum have a lot of debt which makes them very vulnerable if interest rates increase.

Same as the old bank

Brip Blap wrote an interesting post on P2P which indicates that the lender “is the bank”. I have to disagree with this because I think Prosper or Lending Club is the bank. The only thing that really changes is that the p2p lender gets to choose who the borrower is which is not the case when you give money to a regular bank to get interest. Another issue I have is that Prosper and CL seem to be spending a lot of money to get clients - advertising, free money giveaways. Where does this money come from? As far as cutting out the middle man - P2P institutions charge for the loans so I don’t really see how they are very much different from banks.

Statistics

Another concern I have is that I think the interest rates are too good to be true. If a borrower is willing to take my money for 10% then I know that they couldn’t get that same loan at a bank. This is problematic for two reasons -

1. The banks are far better at analyzing debtor risk than you or I (too bad they couldn’t analyze subprime securitization loans) so if they don’t feel the person is worth the risk at 10% then you are not getting a deal - you are getting a high risk loan.
2. If the person seems to have reasonable credit then they might have maxed out all their available credit which implies to me that their credit score is meaningless in that situation.

The fact that p2p has not been around very long also means that any default rates are probably understated. A loan can go into default at any time in the three year term so looking at default rates before three years is not going to be very accurate. Also - with the default rates do they do it by time periods? ie years? if not then any new loans will decrease the default rate dramatically.

Taxation

In the US, interest income is treated as regular income for taxation purposes. Dividends and capital gains are given preferential treatment and you will pay less than than on interest. You will be better off taxation wise to have all three of those investment types in a tax-sheltered account such as a 401(k) or ROTH account. If however you have investments in a taxable account then ideally it should not be fixed income such as bonds or P2P loans. Since P2P loans are not eligible for tax sheltered accounts then the extra taxes will reduce returns significantly.

Asset allocation

Asset allocation or the type of assets you invest in (ie stocks, bonds, cash) is a critical step in the investment process. Personally I have 25% of my investments in fixed income and 75% in equities (stocks). Regardless of the expected rate of return, P2P lending is considered fixed income and it should fit into your desired asset allocation.

Basic economics

If something is too good to be true then it probably isn’t. Currently you can get approximately 4% interest on guaranteed certificates or accounts. If you invest in P2P loans and have an expected return of 10% then that puts you in a much higher risk level and there is a reasonable chance that you could lose 10% or more (much like equities).

Bottom line

I have no plans to invest in p2p loans anytime soon because they don’t fit my investment plan. I do want to make it clear that I’m not suggesting that p2p loans should be avoided or that they are a bad thing. If you know what you are investing in and it fits your investment objectives then go ahead and lend away!