Editor’s note: This article was first published in August 2012. The figures, including deposit rates of 2-3.5%, Spanish 10-year bonds paying over 7%, and the share prices quoted for Ezentis, Natraceutical and Urbas, all reflect that moment.
The current pension system may be in danger, or in the future the pension we receive may be so low that, once we reach old age, it won’t stretch to many luxuries. That’s why private pension plans are starting to matter, and more and more people are aware they need to secure their purchasing power once they retire. Even so, a pension plan is rarely a smart choice. Here are the main drawbacks of pension plans.
The main drawback of a pension plan is very clear: its return is always below inflation. At best, a pension plan is like putting your money in a piggy bank or under the mattress, with the added disadvantage that you can’t use it or withdraw it if you run into financial trouble, except in a handful of cases where you would have to prove you need to get your savings out (and in 80% of cases the request is refused).
Whenever we talk about investment products, we stress the importance of choosing one that is liquid, meaning that we can get at the money whenever we want. Now imagine you have 90,000 € in a pension plan and you need 6,000 € for an emergency, to seize an investment opportunity or simply to start a business. Since you can’t touch that money (which isn’t much), you’ll be forced to take out a bank loan with the corresponding interest. That interest should really be subtracted from the pension plan, because if we had been able to use our own money, we wouldn’t have had to pay it.
So putting money somewhere knowing we won’t be able to touch it for 30 years is too risky, because we don’t know when we’ll need it. People well versed in financial education rarely turn to this kind of savings product. The only reason to take out a pension plan would be its tax advantages, since contributions are deductible on your income tax return. But that would be like investing in the stock market looking to lose, since stock market losses are also deductible.
Two alternatives to a pension plan
Alternative 1: the conservative option (medium return)
Use the usual fixed-income products and keep rolling them over as we see fit, taking advantage of new investment opportunities as they come up. We can start young with an interest-bearing account, paying in each month the amount we would have put into the pension plan.
Once we reach 1,000 €, 2,000 € or 10,000 €, we can move on to fixed-term deposits, where we can get anywhere from 2% to 3.5% a year. At certain times we’ll find some above 4% and close to 5% (that’s in Spain; in other countries deposits above 8% are normal, given their inflation).
If we want a longer-term fixed-income investment, there is sovereign debt. In Spain’s case the 10-year bond has been paying more than 7%, and there are also shorter maturities with attractive returns.
As our investments mature, we look for the ones offering the highest return and reinvest our gains. By the time you retire, using only fixed-income products, we can get more than 60% out of our savings (it could be much more), which would basically be 75% more than a pension plan would have given us over those 30 years.
Alternative 2: a riskier profile, but mathematically controlled
The other alternative is to go to the secondary market and look for listed companies with a small market capitalisation: companies currently trading below one euro, in some cases at less than 20 cents.
See also: Investing in the stock market for beginners
Since we’re talking about an investment of roughly 30 years, we pick 10 companies of this kind. I’ll name a few and then explain the basic maths: Urbas*, Ezentis, Quabit*, Solaria, Natraceutical, Biosearch, Fersa, Vértice 360, and so on. Some of these companies once traded above 20 € and could do so again, although we’ll work with conservative expectations.
I’ve marked Urbas and Quabit with an asterisk because they are in real estate, so they would be the two riskiest, although the first is trying to diversify into renewables. The other day I heard an analyst answer a saver who asked about investing in Urbas when it was trading at 0.011 €. The analyst replied that if he was patient (10–15 years), Urbas could return to its old levels. Well, Urbas once traded above 4 €. In a very positive scenario, with just 100 € we would buy more than 7,000 shares at today’s price. If it went back to those levels, we would have around 28,000 €. Still, I repeat that I personally don’t think those two stocks will reach those levels again, although if they got to just 1 €, we could go out and celebrate in style.
Why do I say the risk is controlled?
I’m sure that one or two of them (maybe even four) will end up trading above 4 €, especially Ezentis (0.145 €), which we really could see back at its all-time highs. There is also the risk that one or two of these companies could cease to exist, but if we spread our capital across them, a single company returning to its old level would give us a three-digit return.
As for Biosearch and Natraceutical, they are biotechnology companies that could have plenty of room to grow once we come out of the crisis.
In short, with just 10,000 € spread across stocks of this kind over 20–30 years, it wouldn’t be crazy to think we could turn it into more than 1 million euros. I could work through combinations of possible scenarios, but that would make the article too heavy, so I’ll use a couple of stocks to give you an idea.
Example 1. If we invest 5,000 € in Ezentis, 3,000 € in Natraceutical and 2,000 € in Urbas, we would have:
- Ezentis: 5,000 ÷ 0.145 = 34,482 shares
- Natraceutical: 3,000 ÷ 0.13 = 23,076 shares
- Urbas: 2,000 ÷ 0.014 = 142,857 shares
Twenty years later:
- Ezentis reaches 15 €. 34,482 × 15 = 517,230 €
- Natraceutical reaches 4 €. 23,076 × 4 = 92,304 €
- Urbas disappears.
In this scenario we would have 609,534 €. This may sound like counting your chickens before they hatch, but after working through every possible combination and taking the worst case, where five of these companies disappear and the other five fall short of expectations, however hard I try to be completely negative, I can’t get a return below 200%.
Another advantage of this approach is that the stock market is a liquid product: if a stock starts behaving unusually at some point, we can sell out and get our money back or put it into other stocks.
As we said in a previous article, anyone who invested 20,000 dollars in Apple in 1999 now has close to 2 million dollars. And that’s much better than a pension plan.
Featured image: Adam Jones from Kelowna, BC, Canada, CC BY-SA 2.0, via Wikimedia Commons.
.jpg){kind=link}