Showing posts with label retirement. Show all posts
Showing posts with label retirement. Show all posts
Friday, October 10, 2008
Crazy week in the market
What a crazy week in the market it has been. Here a just some random thoughts about it. At one point (the market is always changing) the S& P was down 40% for the year. That is a huge number! If we make the assumption that on the average the stock market gives returns of around 7%, this would mean that the average american would have to work 5-6 years just to get back to the principal they had on January 1st. This proabably means they will have to delay retirement that much longer than they would would have planned. There is a big difference in retireing at 65 compared to 70. This also means that new college graduates might not find as many job openings as once thought.
Thursday, October 9, 2008
Retirement
By Stephen Gandel and Paul J. Lim
With stock markets plunging, nest eggs are cracking and retirement dreams are slipping away. But don't hit the panic button yet. With a solid strategy, there's still hope for your golden years.
Will I ever be able to retire?
If you have several years, if not decades, to go, don't worry. Yes, your 401(k) and IRAs have taken a significant hit. But history shows that you'll make up 80% of your bear market losses within the first year of the recovery, according to Standard & Poor's Equity Research.
If you're planning to retire in the next few years, the answer is still yes, with a bit of effort. Why? The decade before you quit your job and the first five years that you're out of the work force are vulnerable times. How much your investments earn - or lose - during this time will go a long way toward determining how much money you can afford to spend for the following 30 years or more.
Say you planned to quit this year and begin withdrawing 4% of your retirement funds annually. If you started with a $1 million retirement portfolio last year (split 70% stocks, 30% bonds), the market has already cut that down to $833,000. That means if you pulled 4% of your remaining money out, you'd be left with just under $800,000 after Year One, cutting your odds of having your money last 30 years from nearly 80% to less than 50%.
Sounds scary. But you can fix this problem. For starters, pledge to work one more year. A study from T. Rowe Price found that putting in another 365 days at the job would boost your annual retirement income by 7%. Work three years more and your retirement income could soar by 22%.
By staying at your desk longer, you can also delay taking Social Security benefits. For each year you put off starting your benefits between ages 62 and 70, you boost your Social Security payments by 8%.
What if you don't want to - or can't - work longer? You still have an option: spend less. The traditional advice is to withdraw 4% of your assets in the first year of retirement and boost subsequent withdrawals by the inflation rate. But in this type of market, consider withholding your inflation adjustments for the first three years after you retire. T. Rowe Price found that a retiree with a 55% stock/45% bond allocation in 2000 would have cut his odds of running out of money by half simply by following this approach.
What should I be doing with my portfolio?
Every long-term investor has to face nerve-rattling times like this - likely more than once - and your success will hinge on your ability to keep a cooler head than many others around you.
If you own a diversified portfolio, your asset-allocation strategy has probably protected you from the worst of the storm. While the S&P 500 has lost more than a quarter of its value over the past year, a portfolio consisting of 70% stocks and 30% bonds has fallen around 17%, thanks to the gains fixed-income funds enjoyed.
Still, markets like this are a good time to check if your asset-allocation strategy is still appropriate for your time horizon and if you need to rebalance. You'll likely find that you own too big a stake in bonds - or at least more than you bargained for.
Let's go back to that portfolio of 70% stocks and 30% bonds. If you hadn't traded in the past year, the market would have shifted your mix to 62% stocks and 38% fixed income. That might feel good now because bonds are less volatile, but it will mean that you will lose out on the higher returns on stocks when the market eventually recovers.
If you're selling bonds to add to stocks, what's safe to buy? It's fair to assume that the government's efforts to bail out Wall Street will add to our national debt, which will likely push up interest rates. Basic-materials stocks tend to do well when rates rise. So consider T. Rowe Price New Era (PRNEX), which owns energy and mining stocks. New Era is a member of the Money 70, our list of recommended funds and ETFs.
Also, beef up your blue chips. As Lehman and WaMu shareholders learned, not every large company can weather tough times. But as a whole, the category clearly can. The Vanguard 500 Index (VFINX) is the safest way to invest in the largest American companies.
Another sound option is the Fairholme fund (FAIRX). The managers of this Money 70 fund follow the Warren Buffett school of investing. They buy a stock only if it's trading well below its intrinsic value - perhaps a richly populated universe after this market meltdown.
If you see that the bond portion of your portfolio is underperforming, consider Treasury Inflation-Protected Securities (TIPS), one of the few types of bonds that can do well when rates rise.
I'm retired. What does this mean for me?
If you're living off a collection of dividend-paying stocks, it may feel as if you've been hit by the perfect storm. Not only have financial stocks, which generate around a quarter of all the dividends produced by the S&P 500, taken a huge beating - they've sunk nearly 45% since the start of this bear - but 30 blue-chip financial firms have cut their dividends.
Worse still, not all of the income you'll receive this year will be eligible for the beneficial 15% tax rate. For dividends to qualify for the rate, the company that issues them must pay taxes on them. And since many banks and brokers are reporting huge losses, they may not owe a penny to Uncle Sam this year.
As long as you diversify among different stocks as well as different sectors, dividend investing still has a lot of appeal. One strategy that's holding up, relatively speaking: Instead of focusing on companies with the highest yields - which could simply be a sign that a payer's share price has tanked or the dividend is at risk - concentrate on companies that are consistently growing their payouts over time. By doing so, the Vanguard Dividend Growth fund (VDIGX) has kept its exposure to the financial sector to only around 11%, and the fund is down just 10% so far this year, about half what the overall market has lost.
In the wake of the near failure of AIG, another worry for retirees is whether to buy an immediate annuity. In exchange for handing over a lump sum of money to an insurer, you get monthly or annual payments guaranteed for life with one of these policies. In this environment, it's hard enough to have faith that your financial institution will be around for the next three months, let alone three decades.
But bear in mind that no major insurer has failed in this meltdown. Even though AIG required $85 billion in loan guarantees to stay in business, it was the parent company that needed the help - not its insurance subsidiary.
In the event your insurer does fail, your state's life and health insurance guaranty association will attempt to find another carrier to take over the failed firm's contracts. If that can't be done, state guaranty funds will cover at least $100,000 in benefits (around 20 states cover more).
There is one reason to hold off awhile before you enter a new contract: Rating agencies like A.M. Best, Moody's, Fitch and Standard & Poor's are likely to re-assess the financial health of insurers in the wake of the financial crisis. Wait to see which insurers maintain the highest ratings.
How will I know when things are recovering?
An oft-quoted Warren Buffett bit of wisdom goes that the stock market is designed to transfer money from the active to the patient. Keep that in mind when you wonder when this crisis is over for good.
Let's remember what this crisis is all about. It's not just about problems with bad mortgages and toxic mortgage-backed bonds. "That's just the tip of the iceberg," says Charles de Vaulx, portfolio manager for International Value Advisers. The reason that we're still stuck in a bear market and that loans are hard to come by is the ongoing crisis in confidence in the financial system that greases the wheels of the economy. It may take months, if not longer, for the markets to get enough courage to overcome this.
Whether you're an investor or a would-be borrower looking for a sign of better days to come, pay attention to the so-called overnight London Interbank offered rate. Libor is a rate banks charge one another. The lower it is, the greater the likelihood that banks are willing to lend freely - and the sooner this credit crisis may be over.
Historically, Libor has run fairly close to the federal funds rate, which the Fed is currently targeting at 2%. But lately the overnight Libor has fluctuated between around 3% and 6%, an indication that banks still perceive a great deal of risk in the market.
In the short run, that's not great news for investors or consumers waiting for banks to start lending again. In the long run, however, the fact that banks are starting to consider risk isn't necessarily bad. After all, says Steven Romick, manager of the FPA Crescent Fund, "the reason we're in this mess is that financial institutions tried to make money without any regard to the concept of risk
With stock markets plunging, nest eggs are cracking and retirement dreams are slipping away. But don't hit the panic button yet. With a solid strategy, there's still hope for your golden years.
Will I ever be able to retire?
If you have several years, if not decades, to go, don't worry. Yes, your 401(k) and IRAs have taken a significant hit. But history shows that you'll make up 80% of your bear market losses within the first year of the recovery, according to Standard & Poor's Equity Research.
If you're planning to retire in the next few years, the answer is still yes, with a bit of effort. Why? The decade before you quit your job and the first five years that you're out of the work force are vulnerable times. How much your investments earn - or lose - during this time will go a long way toward determining how much money you can afford to spend for the following 30 years or more.
Say you planned to quit this year and begin withdrawing 4% of your retirement funds annually. If you started with a $1 million retirement portfolio last year (split 70% stocks, 30% bonds), the market has already cut that down to $833,000. That means if you pulled 4% of your remaining money out, you'd be left with just under $800,000 after Year One, cutting your odds of having your money last 30 years from nearly 80% to less than 50%.
Sounds scary. But you can fix this problem. For starters, pledge to work one more year. A study from T. Rowe Price found that putting in another 365 days at the job would boost your annual retirement income by 7%. Work three years more and your retirement income could soar by 22%.
By staying at your desk longer, you can also delay taking Social Security benefits. For each year you put off starting your benefits between ages 62 and 70, you boost your Social Security payments by 8%.
What if you don't want to - or can't - work longer? You still have an option: spend less. The traditional advice is to withdraw 4% of your assets in the first year of retirement and boost subsequent withdrawals by the inflation rate. But in this type of market, consider withholding your inflation adjustments for the first three years after you retire. T. Rowe Price found that a retiree with a 55% stock/45% bond allocation in 2000 would have cut his odds of running out of money by half simply by following this approach.
What should I be doing with my portfolio?
Every long-term investor has to face nerve-rattling times like this - likely more than once - and your success will hinge on your ability to keep a cooler head than many others around you.
If you own a diversified portfolio, your asset-allocation strategy has probably protected you from the worst of the storm. While the S&P 500 has lost more than a quarter of its value over the past year, a portfolio consisting of 70% stocks and 30% bonds has fallen around 17%, thanks to the gains fixed-income funds enjoyed.
Still, markets like this are a good time to check if your asset-allocation strategy is still appropriate for your time horizon and if you need to rebalance. You'll likely find that you own too big a stake in bonds - or at least more than you bargained for.
Let's go back to that portfolio of 70% stocks and 30% bonds. If you hadn't traded in the past year, the market would have shifted your mix to 62% stocks and 38% fixed income. That might feel good now because bonds are less volatile, but it will mean that you will lose out on the higher returns on stocks when the market eventually recovers.
If you're selling bonds to add to stocks, what's safe to buy? It's fair to assume that the government's efforts to bail out Wall Street will add to our national debt, which will likely push up interest rates. Basic-materials stocks tend to do well when rates rise. So consider T. Rowe Price New Era (PRNEX), which owns energy and mining stocks. New Era is a member of the Money 70, our list of recommended funds and ETFs.
Also, beef up your blue chips. As Lehman and WaMu shareholders learned, not every large company can weather tough times. But as a whole, the category clearly can. The Vanguard 500 Index (VFINX) is the safest way to invest in the largest American companies.
Another sound option is the Fairholme fund (FAIRX). The managers of this Money 70 fund follow the Warren Buffett school of investing. They buy a stock only if it's trading well below its intrinsic value - perhaps a richly populated universe after this market meltdown.
If you see that the bond portion of your portfolio is underperforming, consider Treasury Inflation-Protected Securities (TIPS), one of the few types of bonds that can do well when rates rise.
I'm retired. What does this mean for me?
If you're living off a collection of dividend-paying stocks, it may feel as if you've been hit by the perfect storm. Not only have financial stocks, which generate around a quarter of all the dividends produced by the S&P 500, taken a huge beating - they've sunk nearly 45% since the start of this bear - but 30 blue-chip financial firms have cut their dividends.
Worse still, not all of the income you'll receive this year will be eligible for the beneficial 15% tax rate. For dividends to qualify for the rate, the company that issues them must pay taxes on them. And since many banks and brokers are reporting huge losses, they may not owe a penny to Uncle Sam this year.
As long as you diversify among different stocks as well as different sectors, dividend investing still has a lot of appeal. One strategy that's holding up, relatively speaking: Instead of focusing on companies with the highest yields - which could simply be a sign that a payer's share price has tanked or the dividend is at risk - concentrate on companies that are consistently growing their payouts over time. By doing so, the Vanguard Dividend Growth fund (VDIGX) has kept its exposure to the financial sector to only around 11%, and the fund is down just 10% so far this year, about half what the overall market has lost.
In the wake of the near failure of AIG, another worry for retirees is whether to buy an immediate annuity. In exchange for handing over a lump sum of money to an insurer, you get monthly or annual payments guaranteed for life with one of these policies. In this environment, it's hard enough to have faith that your financial institution will be around for the next three months, let alone three decades.
But bear in mind that no major insurer has failed in this meltdown. Even though AIG required $85 billion in loan guarantees to stay in business, it was the parent company that needed the help - not its insurance subsidiary.
In the event your insurer does fail, your state's life and health insurance guaranty association will attempt to find another carrier to take over the failed firm's contracts. If that can't be done, state guaranty funds will cover at least $100,000 in benefits (around 20 states cover more).
There is one reason to hold off awhile before you enter a new contract: Rating agencies like A.M. Best, Moody's, Fitch and Standard & Poor's are likely to re-assess the financial health of insurers in the wake of the financial crisis. Wait to see which insurers maintain the highest ratings.
How will I know when things are recovering?
An oft-quoted Warren Buffett bit of wisdom goes that the stock market is designed to transfer money from the active to the patient. Keep that in mind when you wonder when this crisis is over for good.
Let's remember what this crisis is all about. It's not just about problems with bad mortgages and toxic mortgage-backed bonds. "That's just the tip of the iceberg," says Charles de Vaulx, portfolio manager for International Value Advisers. The reason that we're still stuck in a bear market and that loans are hard to come by is the ongoing crisis in confidence in the financial system that greases the wheels of the economy. It may take months, if not longer, for the markets to get enough courage to overcome this.
Whether you're an investor or a would-be borrower looking for a sign of better days to come, pay attention to the so-called overnight London Interbank offered rate. Libor is a rate banks charge one another. The lower it is, the greater the likelihood that banks are willing to lend freely - and the sooner this credit crisis may be over.
Historically, Libor has run fairly close to the federal funds rate, which the Fed is currently targeting at 2%. But lately the overnight Libor has fluctuated between around 3% and 6%, an indication that banks still perceive a great deal of risk in the market.
In the short run, that's not great news for investors or consumers waiting for banks to start lending again. In the long run, however, the fact that banks are starting to consider risk isn't necessarily bad. After all, says Steven Romick, manager of the FPA Crescent Fund, "the reason we're in this mess is that financial institutions tried to make money without any regard to the concept of risk
Wednesday, September 24, 2008
Save for Tomorrow be happy today
Money Magazine) -- In a sense, retirement planning is all about deferred gratification. You live below your means while you work so you can save for a time when you can live however you want. In short, you give up something today so you can live better tomorrow.
But what if preparing for retirement had a more immediate payoff? Wouldn't it be neat if you could enjoy the fruits of your effort now?
Well, maybe you already do. That, at least, is the implication of a recent survey by insurer Northwestern Mutual and health education company LLuminari. The study didn't address retirement per se.
But as the charts to the right show, people who do the sorts of things that constitute good planning tend to feel happier than those who don't. It appears that the very act of preparing for retirement may deliver a reward now as well as later.
No one is suggesting that getting ready for your post-career days guarantees lifelong bliss or that there's a formula for achieving nirvana. (Save an extra $100 a month and be 50% more fulfilled!)
But the notion that taking steps toward a secure retirement can make you more content is hardly a stretch. Economists, psychologists and others who study happiness find that people who have a sense of control over their lives cope better with stress and live more happily, while those who feel powerless are more likely to be depressed.
Or as the playwright George Bernard Shaw put it: "To be in hell is to drift; to be in heaven is to steer."
So what can you do to make yourself feel better about feathering your nest? Apply these three happiness-linked actions to your retirement planning:
Set goals
If you fail to set goals early on, you'll be drifting instead of steering. So think about the percentage of pre-retirement income you'll want to replace once you retire - say, 80% to 90%. Then use a calculator like our Retirement Planner to see how much you must save each year to have a shot at reaching that goal. Keep refining your savings target as you near retirement.
Take steps to achieve your goals
If the amount you're putting into your 401(k) falls short of your savings target, boost your contribution. If maxing out your 401(k) still leaves a gap, you can funnel additional savings into an IRA or tax-efficient options like index funds or tax-managed funds.
Control debt
It's unrealistic to avoid borrowing altogether. But you can prevent debt from undermining your retirement security by not carrying a credit-card balance. Not only will you avoid onerous interest charges, but the Northwestern study shows that people who are most committed to paying off their cards are almost 20% more likely to describe themselves as cheerful.
So the next time you're trying to decide between a higher 401(k) contribution and a big-screen TV, you might want to go with the option that may make you feel good now and in the years ahead.
By Walter Updegrave, Money Magazine senior editor
But what if preparing for retirement had a more immediate payoff? Wouldn't it be neat if you could enjoy the fruits of your effort now?
Well, maybe you already do. That, at least, is the implication of a recent survey by insurer Northwestern Mutual and health education company LLuminari. The study didn't address retirement per se.
But as the charts to the right show, people who do the sorts of things that constitute good planning tend to feel happier than those who don't. It appears that the very act of preparing for retirement may deliver a reward now as well as later.
No one is suggesting that getting ready for your post-career days guarantees lifelong bliss or that there's a formula for achieving nirvana. (Save an extra $100 a month and be 50% more fulfilled!)
But the notion that taking steps toward a secure retirement can make you more content is hardly a stretch. Economists, psychologists and others who study happiness find that people who have a sense of control over their lives cope better with stress and live more happily, while those who feel powerless are more likely to be depressed.
Or as the playwright George Bernard Shaw put it: "To be in hell is to drift; to be in heaven is to steer."
So what can you do to make yourself feel better about feathering your nest? Apply these three happiness-linked actions to your retirement planning:
Set goals
If you fail to set goals early on, you'll be drifting instead of steering. So think about the percentage of pre-retirement income you'll want to replace once you retire - say, 80% to 90%. Then use a calculator like our Retirement Planner to see how much you must save each year to have a shot at reaching that goal. Keep refining your savings target as you near retirement.
Take steps to achieve your goals
If the amount you're putting into your 401(k) falls short of your savings target, boost your contribution. If maxing out your 401(k) still leaves a gap, you can funnel additional savings into an IRA or tax-efficient options like index funds or tax-managed funds.
Control debt
It's unrealistic to avoid borrowing altogether. But you can prevent debt from undermining your retirement security by not carrying a credit-card balance. Not only will you avoid onerous interest charges, but the Northwestern study shows that people who are most committed to paying off their cards are almost 20% more likely to describe themselves as cheerful.
So the next time you're trying to decide between a higher 401(k) contribution and a big-screen TV, you might want to go with the option that may make you feel good now and in the years ahead.
By Walter Updegrave, Money Magazine senior editor
Thursday, September 11, 2008
Risk
(Money Magazine) -- The classic vision of retirement planning goes something like this: You start broke. You invest as best you can, and if nothing goes too terribly wrong, you finish with enough money to support yourself.
Retirement expert Moshe A. Milevsky, an associate professor at York University's business school in Toronto, sees it a bit differently. In his view, you start with all the wealth you need in the form of your lifetime earning power. Your job is to convert that personal asset as efficiently as possible into financial assets you can live off once your earning power runs out.
As for things going terribly wrong: Well, odds are that at some point in your life they will. So the key to retirement success, he says, is to identify and ensure against the risks that could knock you off track.
Milevsky's own life offers a prime lesson in how a chance event can derail the best-laid plans. He was studying graduate-level math and physics at Toronto's York University - envisioning a career "smashing atoms together," as he puts it - when his father died of cancer at age 50. The oldest of five children, Milevsky was forced to become a quick expert on his family's money.
The experience shifted his focus from academic physics to the practical math of personal finance and risk management. That unusual angle has defined his career and inspired the Individual Finance and Insurance Decisions Centre, the think tank that he founded eight years ago.
It's also the subject of the latest of his five books, "Are You a Stock or a Bond?", which lays out his views on retirement planning. In late August he spoke with managing editor Eric Schurenberg.
Question: Most advisers say the way to handle risk in retirement planning is to start out investing aggressively, with a lot of stocks in your portfolio, then gradually shift into safer assets like bonds as you get older. What's wrong with that?
Answer: It's an oversimplification. How long you have until retirement is one thing to consider when deciding how much risk to take. But there are many other variables.
Q. Like what?
A. The key is what economists call your human capital. Early in life, you tend to have very few financial assets - investments you can sell for money - but you do have a lot of time in the labor force in front of you, and that is your most valuable asset. As your career goes on, you earn a salary and devote some of it to acquiring investments. So the goal of investment management during your working life is to efficiently convert your human capital into financial capital.
Q. What does that mean other than saving adequately and investing wisely?
A. You also need to look at the risk inherent in your human capital: How stable is your job, how dependent is it on financial markets, how related is it to the economy as a whole? If you have a stable income that doesn't rise or fall with the stock market, you should have more money in stocks than the usual investment model for someone your age says you should. Otherwise - if, say, you work in the securities industry, where your income is likely to hinge a lot on the stock market - you need to invest more heavily than you might think in safe and secure bonds.
Q. Most advisers would say you also have to consider whether you have the nerve to handle a higher or lower level of risk.
A. I think advisers tend to take the mental aspect a little too far. People's risk tolerance changes every day. Yesterday the market is up: People are risk tolerant. Today the market plummets: They're no longer risk tolerant. You should build your retirement portfolios on something more stable than just your mood this morning.
Q. Have you designed your own portfolio built around your human capital?
A. Absolutely. As a tenured professor, with a very predictable income stream, I view my human capital as a bond. So to diversify, I have all my portfolio in stocks. In fact I've borrowed to invest more in stocks, so I'm actually 150% in equities.
Q. Must have been a tough year for you.
A. Yeah, the last few months have not been pretty. To take the sting out of the losses on my brokerage statement, every month or so I open a spreadsheet and recalculate all my capital, human and financial. As I said, my human capital is essentially a bond, so it has been rising in value as interest rates go down. That makes me feel better.
Q. That exercise would be less comforting, I'd imagine, to people who are close to retirement and have used up most of their human capital.
A. True. In the years right before and right after retirement, your financial security is very sensitive to market fluctuations and other risks that were not such an issue before. You need to change your mind-set from wealth accumulation to risk management.
Q. What are the risks?
A. I've run thousands of simulations of hypothetical retirements and ranked what can go wrong. Far and away the biggest causes of failure are longevity risk, inflation and a sour market early in retirement.
Q. Take us through them.
A. Longevity risk - the chance that you'll live too long for your savings - is particularly hard to plan around. Your retirement can literally last anywhere from 10 to 40 years. That wasn't a problem when you could count on a traditional "check a month for life" pension. But odds are, your employer doesn't offer one anymore.
Inflation is something you don't need to worry about in early or mid-career, when most of your wealth is in the form of human capital. That's because wages tend to keep up with inflation. But once you retire and your wealth has been transformed into financial capital, you are completely exposed to inflation risk. Over a 25-year retirement - typical for a married couple - inflation at 4% will cut the value of a $1,000 pension check to just $375.
The third big risk is a bear market. Over a few decades, you'll always have a few down markets, of course. When you're working, it doesn't matter whether the down markets occur early in your life or later. As long as you buy and hold, you'll end up with the same amount of money.
But once you retire, it matters a lot when the bear markets hit. If one occurs early in your retirement, your money won't last nearly as long as if it occurs a few years later. That's because if you start making withdrawals on top of market losses, it's hard to ever make up the lost ground.
Q. How do you hedge those risks?
A. No one kind of investment works against all three. So you need to diversify among investment products, just as you need to diversify among stocks and bonds and so on. This matters more than most people think.
Q. What investment products are we talking about?
A. One category is pensions or annuities, typically a fixed monthly check that an insurance company or pension fund guarantees to keep sending you as long as you live. That's a great solution to longevity risk.
But it's not much help against inflation, which will erode the value of any fixed payment over time. So you also need the traditional mutual fund portfolio that you manage and from which you withdraw funds over an extended period. You can choose high-returning assets like stock funds, which you'd expect to stay ahead of inflation over time.
On the other hand, those are exactly the assets that leave you vulnerable to a market downturn early in your retirement. That's where the third category comes in: the new generation of variable annuities with living benefits. They essentially promise you some upside linked to the stock market but at the same time guarantee you a minimum income for the rest of your life, regardless of when a bear market lands during your retirement.
Q. Your own research years ago showed variable annuities to be way overpriced for the benefits they provided. What changed your mind?
A. If today's variable annuities looked like the product of the same name 10 years ago, I'd still be opposed to them. They used to promise to make up losses only if you died while the market was down.
But the new ones deliver benefits you can claim while you're still alive. And the protection they provide against market losses would be very expensive if you tried to buy it some other way - say, in the options market.
So I used to be something of a crusader against variable annuities, but now I fall back on what the economist John Maynard Keynes said when someone challenged him for supposedly flip-flopping. "When the facts change," he said, "I change my mind. What do you do, sir?"
Retirement expert Moshe A. Milevsky, an associate professor at York University's business school in Toronto, sees it a bit differently. In his view, you start with all the wealth you need in the form of your lifetime earning power. Your job is to convert that personal asset as efficiently as possible into financial assets you can live off once your earning power runs out.
As for things going terribly wrong: Well, odds are that at some point in your life they will. So the key to retirement success, he says, is to identify and ensure against the risks that could knock you off track.
Milevsky's own life offers a prime lesson in how a chance event can derail the best-laid plans. He was studying graduate-level math and physics at Toronto's York University - envisioning a career "smashing atoms together," as he puts it - when his father died of cancer at age 50. The oldest of five children, Milevsky was forced to become a quick expert on his family's money.
The experience shifted his focus from academic physics to the practical math of personal finance and risk management. That unusual angle has defined his career and inspired the Individual Finance and Insurance Decisions Centre, the think tank that he founded eight years ago.
It's also the subject of the latest of his five books, "Are You a Stock or a Bond?", which lays out his views on retirement planning. In late August he spoke with managing editor Eric Schurenberg.
Question: Most advisers say the way to handle risk in retirement planning is to start out investing aggressively, with a lot of stocks in your portfolio, then gradually shift into safer assets like bonds as you get older. What's wrong with that?
Answer: It's an oversimplification. How long you have until retirement is one thing to consider when deciding how much risk to take. But there are many other variables.
Q. Like what?
A. The key is what economists call your human capital. Early in life, you tend to have very few financial assets - investments you can sell for money - but you do have a lot of time in the labor force in front of you, and that is your most valuable asset. As your career goes on, you earn a salary and devote some of it to acquiring investments. So the goal of investment management during your working life is to efficiently convert your human capital into financial capital.
Q. What does that mean other than saving adequately and investing wisely?
A. You also need to look at the risk inherent in your human capital: How stable is your job, how dependent is it on financial markets, how related is it to the economy as a whole? If you have a stable income that doesn't rise or fall with the stock market, you should have more money in stocks than the usual investment model for someone your age says you should. Otherwise - if, say, you work in the securities industry, where your income is likely to hinge a lot on the stock market - you need to invest more heavily than you might think in safe and secure bonds.
Q. Most advisers would say you also have to consider whether you have the nerve to handle a higher or lower level of risk.
A. I think advisers tend to take the mental aspect a little too far. People's risk tolerance changes every day. Yesterday the market is up: People are risk tolerant. Today the market plummets: They're no longer risk tolerant. You should build your retirement portfolios on something more stable than just your mood this morning.
Q. Have you designed your own portfolio built around your human capital?
A. Absolutely. As a tenured professor, with a very predictable income stream, I view my human capital as a bond. So to diversify, I have all my portfolio in stocks. In fact I've borrowed to invest more in stocks, so I'm actually 150% in equities.
Q. Must have been a tough year for you.
A. Yeah, the last few months have not been pretty. To take the sting out of the losses on my brokerage statement, every month or so I open a spreadsheet and recalculate all my capital, human and financial. As I said, my human capital is essentially a bond, so it has been rising in value as interest rates go down. That makes me feel better.
Q. That exercise would be less comforting, I'd imagine, to people who are close to retirement and have used up most of their human capital.
A. True. In the years right before and right after retirement, your financial security is very sensitive to market fluctuations and other risks that were not such an issue before. You need to change your mind-set from wealth accumulation to risk management.
Q. What are the risks?
A. I've run thousands of simulations of hypothetical retirements and ranked what can go wrong. Far and away the biggest causes of failure are longevity risk, inflation and a sour market early in retirement.
Q. Take us through them.
A. Longevity risk - the chance that you'll live too long for your savings - is particularly hard to plan around. Your retirement can literally last anywhere from 10 to 40 years. That wasn't a problem when you could count on a traditional "check a month for life" pension. But odds are, your employer doesn't offer one anymore.
Inflation is something you don't need to worry about in early or mid-career, when most of your wealth is in the form of human capital. That's because wages tend to keep up with inflation. But once you retire and your wealth has been transformed into financial capital, you are completely exposed to inflation risk. Over a 25-year retirement - typical for a married couple - inflation at 4% will cut the value of a $1,000 pension check to just $375.
The third big risk is a bear market. Over a few decades, you'll always have a few down markets, of course. When you're working, it doesn't matter whether the down markets occur early in your life or later. As long as you buy and hold, you'll end up with the same amount of money.
But once you retire, it matters a lot when the bear markets hit. If one occurs early in your retirement, your money won't last nearly as long as if it occurs a few years later. That's because if you start making withdrawals on top of market losses, it's hard to ever make up the lost ground.
Q. How do you hedge those risks?
A. No one kind of investment works against all three. So you need to diversify among investment products, just as you need to diversify among stocks and bonds and so on. This matters more than most people think.
Q. What investment products are we talking about?
A. One category is pensions or annuities, typically a fixed monthly check that an insurance company or pension fund guarantees to keep sending you as long as you live. That's a great solution to longevity risk.
But it's not much help against inflation, which will erode the value of any fixed payment over time. So you also need the traditional mutual fund portfolio that you manage and from which you withdraw funds over an extended period. You can choose high-returning assets like stock funds, which you'd expect to stay ahead of inflation over time.
On the other hand, those are exactly the assets that leave you vulnerable to a market downturn early in your retirement. That's where the third category comes in: the new generation of variable annuities with living benefits. They essentially promise you some upside linked to the stock market but at the same time guarantee you a minimum income for the rest of your life, regardless of when a bear market lands during your retirement.
Q. Your own research years ago showed variable annuities to be way overpriced for the benefits they provided. What changed your mind?
A. If today's variable annuities looked like the product of the same name 10 years ago, I'd still be opposed to them. They used to promise to make up losses only if you died while the market was down.
But the new ones deliver benefits you can claim while you're still alive. And the protection they provide against market losses would be very expensive if you tried to buy it some other way - say, in the options market.
So I used to be something of a crusader against variable annuities, but now I fall back on what the economist John Maynard Keynes said when someone challenged him for supposedly flip-flopping. "When the facts change," he said, "I change my mind. What do you do, sir?"
Wednesday, September 10, 2008
Warning Retiremnet Ahead Part 2
PLOT TWIST: So you've recalculated and figure working just a few more years will put retirement in the bag. But someone forgot to tell your boss.
Unfortunately, when you hit your fifties and sixties, you can't count on job security. Munnell and colleague Steven Sass calculate that only 44% of men working between the ages of 58 and 62 are with the same company that employed them at age 50, compared with 70% two decades ago. While some of those job changes are voluntary, many are the result of employers in a tough economy trying to push out older, highly paid workers with early-retirement offers.
Just ask software engineer Brian Campbell, 51, of Glendale, Ariz., who had spent his entire 28-year career with the same company until he was laid off earlier this year. He and his wife Merna, 50, an accountant who earns $40,000 a year, have more than $600,000 saved for retirement, and Brian received a generous exit package. But he knows that's not nearly enough to support them comfortably for the next 40 or more years, and he worries about what will happen if he can't find work soon. "We're going to have to really downsize our standard of living to get by on my wife's salary," he says.
Everyone in the 10- to 15-year stretch before traditional retirement age needs to realize they could be let go at any time and prepare in advance, advises John Challenger, CEO of the outplacement firm Challenger Gray & Christmas. He suggests devoting the equivalent of 10% of your work time to activities outside your current job that will help you find your next one. Join an industry trade group. Attend conferences. Connect with colleagues outside your firm as well as inside; your next job could be one division away. Get your profile up on professional networking sites like LinkedIn.
Next: Polish your skills. Your résumé should look as au courant as a recent college grad's in terms of your knowledge of the latest technology and industry practices. "You hear so much about diversifying your retirement portfolio to ensure success, but it's just as important to diversify your career portfolio to make sure you stay relevant," says Mitchell.
If you do find yourself back in the job market after eons at the same company, make peace with the fact that you may have to accept a lower salary, Challenger says.
"Often people who've been at a firm a long time are paid above market because they have a specific knowledge of how that firm works or a specific skill that was highly valued at that firm," he says. "New employers aren't necessarily going to care." Instead, he urges, think of yourself as a house that needs to sell in a soft market: Set your price too high and you won't get offers.
PLOT TWIST: You check your 401(k) and see stocks have been in The Big Sleep for a decade. You want to put all your dough back in the mattress.
When former IBM vice president Gil Saenz, 58, retired two years ago, he didn't anticipate the market's recent swoon, which has reduced his 401(k) balance from $450,000 to $350,000. Saenz and his wife Sherry, 55, a retired criminal defense attorney, still have another $350,000 in a taxable investment account, bringing their total assets to a not-too-shabby $700,000. The $100,000 in losses (on paper, at least) made Saenz question his commitment to stocks, though. "In hindsight I should have cashed out," he says.
Plenty of near and recent retirees share Saenz's discomfort with stocks. But while it's understandable that the mantra "time is on my side" doesn't resonate as convincingly now as it did when you were in your thirties and forties, that's only because you're focused on the wrong finish line.
"The issue is not when you retire but how long you then expect to need income from your retirement savings," says Christopher Jones, chief investment officer at Financial Engines and author of The Intelligent Portfolio. "With that longer perspective - 30 years or more - keeping some of your money in stocks is the only way you'll get the growth you need to beat inflation."
A recent study by T. Rowe Price demonstrates how keeping a substantial portion of your savings in stocks boosts the odds that your money will outlast you. The firm ran 100,000 market and asset-allocation scenarios to gauge the effects on financial security over a 30-year retirement, assuming a $500,000 starting portfolio, an initial 4% withdrawal rate and 3% annual raises in that withdrawal to account for inflation. A portfolio 60% in stocks and 40% in bonds got the best results: It had an 87% shot at generating the income needed, with a median $395,000 left at the end of the 30 years should you need it. Dial the stock stake down to 20% and you'd be just as likely to get the income you need, but you'd be left with a cushion of only $180,000.
What's your dream retirement?
In fact, many financial advisers recommend that after the sharp decline in stocks over the past year, you should boost the percentage of your retirement account that's invested in stocks, not reduce it.
"It may go against your instincts, but rebalancing is important now to keep your stock allocation in place," says Christine Fahlund, a senior financial planner at T. Rowe Price. "You might even want to raise your stock allocation by 5% or so, since you can buy shares these days at much lower prices."
To dampen the risks of owning stocks in the short run, however, make sure you've spread your money among different kinds of shares - big and small company stocks, for instance, with at least 20% in foreign markets and no more than 5% to 10% of the total in shares of your own employer. It seems that many people have trouble with that last part: Financial Engines reports that 43% of 401(k) participants over the age of 60 have at least double that amount in unrestricted company stock. (For help with the right mix, check out the Asset Allocation tool.)
THE SURPRISE ENDING: You finally have the money to make a clean exit. Then, as soon as you stop working, the bottom falls out of the stock market.
Stocks held for the long term can be counted on to bounce back eventually. But if you need to sell shares just as they're dropping in value - exactly the scenario many newly minted retirees have faced over the past year - you run a sharply higher risk that your money will someday run out.
That's because when the market does recover, you'll have less money invested to benefit from renewed growth. Fortunately, there's a minor tweak that can dramatically cut your risk: Instead of following the recommended regimen of withdrawing 4% from your savings in the first year of retirement, then boosting your payouts by 3% each year to compensate for inflation, give up the inflation adjustment until stocks recover. A study by T. Rowe Price concludes that this simple step cuts the odds of running out of money over a 30- year period in half, from 22% to 11%, on a sample portfolio invested 55% in stocks and 45% in bonds.
Worried that forgoing your inflation raise will bust your budget? Pull a Brett Favre and go back to work part time to make up the "lost" income. You probably won't need to put in more than a few hours a week - a 3% increase on a $75,000 annual withdrawal equals only $200 a month.
You can also buy yourself some extra protection for those later years of retirement with a longevity annuity. Unlike an immediate annuity, which starts feeding you income as soon as you make the purchase - typically in your sixties - a longevity annuity makes payments only once you reach 85 or so. And it costs a lot less: Financial Engines estimates that you'll spend 8% to 15% of your retirement stash at age 65 to purchase a longevity annuity that starts payments at age 85 vs. 60% to 70% for an immediate annuity that generates the same income but starts payments 20 years earlier.
So if you retire at 65, an annuity that pays you $55,000 a year right away might run about $600,000; sign up to get the same $55,000 a year, only with payments not scheduled to start until age 85, and you'll pay about $115,000. Adding this guaranteed income source later in life might also enable you to leave more in your estate - a bonus if you're starting to worry about the best way to leave money to your heirs.
Happy ending. You just made it through the dangerous passage. Better yet: You've helped your kids handle the sequel.
Unfortunately, when you hit your fifties and sixties, you can't count on job security. Munnell and colleague Steven Sass calculate that only 44% of men working between the ages of 58 and 62 are with the same company that employed them at age 50, compared with 70% two decades ago. While some of those job changes are voluntary, many are the result of employers in a tough economy trying to push out older, highly paid workers with early-retirement offers.
Just ask software engineer Brian Campbell, 51, of Glendale, Ariz., who had spent his entire 28-year career with the same company until he was laid off earlier this year. He and his wife Merna, 50, an accountant who earns $40,000 a year, have more than $600,000 saved for retirement, and Brian received a generous exit package. But he knows that's not nearly enough to support them comfortably for the next 40 or more years, and he worries about what will happen if he can't find work soon. "We're going to have to really downsize our standard of living to get by on my wife's salary," he says.
Everyone in the 10- to 15-year stretch before traditional retirement age needs to realize they could be let go at any time and prepare in advance, advises John Challenger, CEO of the outplacement firm Challenger Gray & Christmas. He suggests devoting the equivalent of 10% of your work time to activities outside your current job that will help you find your next one. Join an industry trade group. Attend conferences. Connect with colleagues outside your firm as well as inside; your next job could be one division away. Get your profile up on professional networking sites like LinkedIn.
Next: Polish your skills. Your résumé should look as au courant as a recent college grad's in terms of your knowledge of the latest technology and industry practices. "You hear so much about diversifying your retirement portfolio to ensure success, but it's just as important to diversify your career portfolio to make sure you stay relevant," says Mitchell.
If you do find yourself back in the job market after eons at the same company, make peace with the fact that you may have to accept a lower salary, Challenger says.
"Often people who've been at a firm a long time are paid above market because they have a specific knowledge of how that firm works or a specific skill that was highly valued at that firm," he says. "New employers aren't necessarily going to care." Instead, he urges, think of yourself as a house that needs to sell in a soft market: Set your price too high and you won't get offers.
PLOT TWIST: You check your 401(k) and see stocks have been in The Big Sleep for a decade. You want to put all your dough back in the mattress.
When former IBM vice president Gil Saenz, 58, retired two years ago, he didn't anticipate the market's recent swoon, which has reduced his 401(k) balance from $450,000 to $350,000. Saenz and his wife Sherry, 55, a retired criminal defense attorney, still have another $350,000 in a taxable investment account, bringing their total assets to a not-too-shabby $700,000. The $100,000 in losses (on paper, at least) made Saenz question his commitment to stocks, though. "In hindsight I should have cashed out," he says.
Plenty of near and recent retirees share Saenz's discomfort with stocks. But while it's understandable that the mantra "time is on my side" doesn't resonate as convincingly now as it did when you were in your thirties and forties, that's only because you're focused on the wrong finish line.
"The issue is not when you retire but how long you then expect to need income from your retirement savings," says Christopher Jones, chief investment officer at Financial Engines and author of The Intelligent Portfolio. "With that longer perspective - 30 years or more - keeping some of your money in stocks is the only way you'll get the growth you need to beat inflation."
A recent study by T. Rowe Price demonstrates how keeping a substantial portion of your savings in stocks boosts the odds that your money will outlast you. The firm ran 100,000 market and asset-allocation scenarios to gauge the effects on financial security over a 30-year retirement, assuming a $500,000 starting portfolio, an initial 4% withdrawal rate and 3% annual raises in that withdrawal to account for inflation. A portfolio 60% in stocks and 40% in bonds got the best results: It had an 87% shot at generating the income needed, with a median $395,000 left at the end of the 30 years should you need it. Dial the stock stake down to 20% and you'd be just as likely to get the income you need, but you'd be left with a cushion of only $180,000.
What's your dream retirement?
In fact, many financial advisers recommend that after the sharp decline in stocks over the past year, you should boost the percentage of your retirement account that's invested in stocks, not reduce it.
"It may go against your instincts, but rebalancing is important now to keep your stock allocation in place," says Christine Fahlund, a senior financial planner at T. Rowe Price. "You might even want to raise your stock allocation by 5% or so, since you can buy shares these days at much lower prices."
To dampen the risks of owning stocks in the short run, however, make sure you've spread your money among different kinds of shares - big and small company stocks, for instance, with at least 20% in foreign markets and no more than 5% to 10% of the total in shares of your own employer. It seems that many people have trouble with that last part: Financial Engines reports that 43% of 401(k) participants over the age of 60 have at least double that amount in unrestricted company stock. (For help with the right mix, check out the Asset Allocation tool.)
THE SURPRISE ENDING: You finally have the money to make a clean exit. Then, as soon as you stop working, the bottom falls out of the stock market.
Stocks held for the long term can be counted on to bounce back eventually. But if you need to sell shares just as they're dropping in value - exactly the scenario many newly minted retirees have faced over the past year - you run a sharply higher risk that your money will someday run out.
That's because when the market does recover, you'll have less money invested to benefit from renewed growth. Fortunately, there's a minor tweak that can dramatically cut your risk: Instead of following the recommended regimen of withdrawing 4% from your savings in the first year of retirement, then boosting your payouts by 3% each year to compensate for inflation, give up the inflation adjustment until stocks recover. A study by T. Rowe Price concludes that this simple step cuts the odds of running out of money over a 30- year period in half, from 22% to 11%, on a sample portfolio invested 55% in stocks and 45% in bonds.
Worried that forgoing your inflation raise will bust your budget? Pull a Brett Favre and go back to work part time to make up the "lost" income. You probably won't need to put in more than a few hours a week - a 3% increase on a $75,000 annual withdrawal equals only $200 a month.
You can also buy yourself some extra protection for those later years of retirement with a longevity annuity. Unlike an immediate annuity, which starts feeding you income as soon as you make the purchase - typically in your sixties - a longevity annuity makes payments only once you reach 85 or so. And it costs a lot less: Financial Engines estimates that you'll spend 8% to 15% of your retirement stash at age 65 to purchase a longevity annuity that starts payments at age 85 vs. 60% to 70% for an immediate annuity that generates the same income but starts payments 20 years earlier.
So if you retire at 65, an annuity that pays you $55,000 a year right away might run about $600,000; sign up to get the same $55,000 a year, only with payments not scheduled to start until age 85, and you'll pay about $115,000. Adding this guaranteed income source later in life might also enable you to leave more in your estate - a bonus if you're starting to worry about the best way to leave money to your heirs.
Happy ending. You just made it through the dangerous passage. Better yet: You've helped your kids handle the sequel.
Warning Retiremnet Ahead Part 1
Money Magazine) -- The decade before you quit the work force, along with the five years immediately after, is the most sensitive period in an entire lifetime of retirement planning. The saving, investment and career decisions you make during this time will dictate in a major way whether you'll spend the next 30 to 40 years enjoying the life you've always looked forward to or eating the early-bird special at Denny's.
Even if you do everything right, perils outside of your control lurk at every turn: A parent or adult child suddenly needs your financial help, so you can't save as much as you'd planned. You develop a health problem and are forced to stop working sooner than you expected. An employer pushes you into early retirement. Or the financial markets suddenly and sharply turn against you. Sound familiar?
Welcome to the Dangerous Passage, starring...you.
"It's natural to have a queasy feeling at this time in your life, wondering if your retirement will happen as planned," says Joseph Chadwick of the Longevity Alliance, a financial services firm that specializes in retirement products. "But there's no need to panic."
Dim the lights to view the plot twists you may encounter and the strategies you need to follow to keep your story moving in the right direction. Understand that whatever dangers you face, you still have time. You just need to do what Hollywood does when the script isn't building to the desired ending: rewrite.
OPENING SCENE: Retirement is closing in like G-men on the heels of Bonnie and Clyde. But you don't have the dough you need.
Sure, you've been steadily contributing to your 401(k) and IRA for years now. But it's still awfully hard to amass as much as the experts say you'll need. The numbers are ridiculously daunting: If you're currently in your fifties, your retirement portfolio at this point should be worth six to eight times your salary. By 60 you should have saved about 11 times your income, and by 65 the equivalent of 15 times your earnings.
And the markets aren't exactly helping matters lately. The housing slump has thwarted dreams of cashing in and retiring on the house, while lackluster stock market returns haven't provided the gains you were banking on. "For much of the past 25 years the markets did most of the work for you, but you can't expect them to carry you in the future," warns Bill Bengen, a financial adviser in El Cajon, Calif. He adds, "The only way you'll reach your retirement goal is to commit to having more money pulled out of your paycheck."
You probably have plenty of opportunity to save more in taxadvantaged plans. In a recent survey of nearly a million 401(k) accounts, retirement research firm Financial Engines found that a quarter of 401(k) investors 50 or older don't even contribute enough to qualify for the maximum employer match (typically 50% of the amount you put in, up to 6% of your salary).
And only 6% of eligible participants take full advantage of catch-up provisions that allow those 50 or older to save an extra $5,000 a year in a 401(k), for a total of $20,500 this year (you can put an additional $1,000 in an IRA, or up to $6,000 in 2008).
Ultimate guide to retirement
The time to start pumping up those contributions is now, right now, even if you plan to stay in the work force another 10 years or more. Because you never know when something could happen to change your plans. More than a fifth of the retirees in a Sun Life survey reported that they had been forced into retirement, eight years earlier than expected on average, typically because of downsizing or ill health.
And if you do keep working, the sooner you get with the savings program, the greater the benefit. A couple who manage to save an extra $10,000 a year for 10 years - that is, who both max out their catch-up contributions - could retire with an extra $152,000, assuming they earn an average of 8% a year.
Before you convince yourself that kicking in $416 more a month (which is what $5,000 a year amounts to) will put you in a financial bind, go ahead and try it. Automating contributions is often all that it takes to get on - and stay on - a more rigorous savings plan. Then put some elbow grease into wringing any excess out of your spending so you don't feel a financial pinch. "
From making your home more energy-efficient to limiting your shopping to mostly sale items, it's amazing how a lot of small savings can help over time," says financial adviser Lou Stanasolovich, founder of Legend Financial Advisors in Pittsburgh. Rethinking your bigger-ticket expenditures will, of course, help matters too. "I am always amazed when people tell me they just spent $10,000 on a big family vacation but then complain about how they can't afford to contribute more money to their 401(k)," says Stanasolovich.
PLOT TWIST: Okay, okay, you're all set to start saving more - a lot more. Then your kid shows up with an acceptance letter to NYU.
In theory, saving more should be easier now than at any other time in your life. After all, you're in your peak earning years and are mostly done with establishing a comfortable home and raising a family and paying the hefty bills that go with that.
If only. You may be past orthodontics and summer camp - and that's a big maybe given the older age at which many boomers started families - but you're likely still spending serious money on your kids. Nearly 60% of boomers and almost 40% of those 60 and older with children over 18 say they're still supporting them to some degree, from paying for college to lending a hand with rent, a car or other expenses, the Pew Research Center reports. Nearly 30% of boomers are also supporting an aging parent, sometimes at the same time as they're helping their kids.
What's your dream retirement?
So if family responsibilities prevent you from saving as much as you should, where will the extra money you need for retirement come from? "Working longer is the best possible safety valve to ensure you will have enough retirement income," says Olivia Mitchell, head of the Boettner Center for Pensions and Retirement Security at the University of Pennsylvania. "Every year you delay retirement is a year you can save more and a year you don't draw down your savings."
Adds Alicia Munnell, director of Boston College's Center for Retirement Research: "No one is suggesting you have to keep working until you are 90. Just two or three more years will help tremendously."
The math is compelling. According to an analysis by T. Rowe Price, every year you postpone retirement adds about 7% to the retirement income you can eventually expect to earn from your investments. A 62-year-old who delays his exit from the work force until age 65 will see the income generated from his retirement account rise 22% (based on a salary of $100,000, a well-diversified portfolio worth $500,000 and 15% annual salary contributions); if he waits until 67, he'll get 39% more.
Staying on the payroll longer likely also means you'll be able to postpone drawing Social Security benefits. While you can collect starting as early as age 62, your benefits will be permanently reduced if you do; every year you delay between ages 62 and 70 adds 8% to your eventual payout. For example, someone who retires this year and qualifies for the maximum early benefit can collect $20,244. Put off drawing the benefit until age 70 and the annual payout will be $35,629 (in today's dollars).
Working longer is the wonder cure for a multitude of ailments that can imperil your retirement plan. It buys time for your portfolio to recover from the market's recent nosedive. And it helps keep health-care costs in check until you qualify for Medicare at age 65.
That's why Julius Roy is still behind the counter as a pharmacist in Slidell, La. at 60 and why he intends to stay there a few more years. Although Julius and his wife Diane, 64, also a pharmacist, have more than $1.6 million in their investment accounts, he doesn't want to give up his employer-provided health insurance. Having undergone double bypass surgery when he was 40, he figures he'd have a tough time qualifying for a private policy and might still face big expenses if he was hit by a major illness. "Staying at work a few more years to stay insured could make all the difference to my financial security in the long run," Julius says.
Even if you do everything right, perils outside of your control lurk at every turn: A parent or adult child suddenly needs your financial help, so you can't save as much as you'd planned. You develop a health problem and are forced to stop working sooner than you expected. An employer pushes you into early retirement. Or the financial markets suddenly and sharply turn against you. Sound familiar?
Welcome to the Dangerous Passage, starring...you.
"It's natural to have a queasy feeling at this time in your life, wondering if your retirement will happen as planned," says Joseph Chadwick of the Longevity Alliance, a financial services firm that specializes in retirement products. "But there's no need to panic."
Dim the lights to view the plot twists you may encounter and the strategies you need to follow to keep your story moving in the right direction. Understand that whatever dangers you face, you still have time. You just need to do what Hollywood does when the script isn't building to the desired ending: rewrite.
OPENING SCENE: Retirement is closing in like G-men on the heels of Bonnie and Clyde. But you don't have the dough you need.
Sure, you've been steadily contributing to your 401(k) and IRA for years now. But it's still awfully hard to amass as much as the experts say you'll need. The numbers are ridiculously daunting: If you're currently in your fifties, your retirement portfolio at this point should be worth six to eight times your salary. By 60 you should have saved about 11 times your income, and by 65 the equivalent of 15 times your earnings.
And the markets aren't exactly helping matters lately. The housing slump has thwarted dreams of cashing in and retiring on the house, while lackluster stock market returns haven't provided the gains you were banking on. "For much of the past 25 years the markets did most of the work for you, but you can't expect them to carry you in the future," warns Bill Bengen, a financial adviser in El Cajon, Calif. He adds, "The only way you'll reach your retirement goal is to commit to having more money pulled out of your paycheck."
You probably have plenty of opportunity to save more in taxadvantaged plans. In a recent survey of nearly a million 401(k) accounts, retirement research firm Financial Engines found that a quarter of 401(k) investors 50 or older don't even contribute enough to qualify for the maximum employer match (typically 50% of the amount you put in, up to 6% of your salary).
And only 6% of eligible participants take full advantage of catch-up provisions that allow those 50 or older to save an extra $5,000 a year in a 401(k), for a total of $20,500 this year (you can put an additional $1,000 in an IRA, or up to $6,000 in 2008).
Ultimate guide to retirement
The time to start pumping up those contributions is now, right now, even if you plan to stay in the work force another 10 years or more. Because you never know when something could happen to change your plans. More than a fifth of the retirees in a Sun Life survey reported that they had been forced into retirement, eight years earlier than expected on average, typically because of downsizing or ill health.
And if you do keep working, the sooner you get with the savings program, the greater the benefit. A couple who manage to save an extra $10,000 a year for 10 years - that is, who both max out their catch-up contributions - could retire with an extra $152,000, assuming they earn an average of 8% a year.
Before you convince yourself that kicking in $416 more a month (which is what $5,000 a year amounts to) will put you in a financial bind, go ahead and try it. Automating contributions is often all that it takes to get on - and stay on - a more rigorous savings plan. Then put some elbow grease into wringing any excess out of your spending so you don't feel a financial pinch. "
From making your home more energy-efficient to limiting your shopping to mostly sale items, it's amazing how a lot of small savings can help over time," says financial adviser Lou Stanasolovich, founder of Legend Financial Advisors in Pittsburgh. Rethinking your bigger-ticket expenditures will, of course, help matters too. "I am always amazed when people tell me they just spent $10,000 on a big family vacation but then complain about how they can't afford to contribute more money to their 401(k)," says Stanasolovich.
PLOT TWIST: Okay, okay, you're all set to start saving more - a lot more. Then your kid shows up with an acceptance letter to NYU.
In theory, saving more should be easier now than at any other time in your life. After all, you're in your peak earning years and are mostly done with establishing a comfortable home and raising a family and paying the hefty bills that go with that.
If only. You may be past orthodontics and summer camp - and that's a big maybe given the older age at which many boomers started families - but you're likely still spending serious money on your kids. Nearly 60% of boomers and almost 40% of those 60 and older with children over 18 say they're still supporting them to some degree, from paying for college to lending a hand with rent, a car or other expenses, the Pew Research Center reports. Nearly 30% of boomers are also supporting an aging parent, sometimes at the same time as they're helping their kids.
What's your dream retirement?
So if family responsibilities prevent you from saving as much as you should, where will the extra money you need for retirement come from? "Working longer is the best possible safety valve to ensure you will have enough retirement income," says Olivia Mitchell, head of the Boettner Center for Pensions and Retirement Security at the University of Pennsylvania. "Every year you delay retirement is a year you can save more and a year you don't draw down your savings."
Adds Alicia Munnell, director of Boston College's Center for Retirement Research: "No one is suggesting you have to keep working until you are 90. Just two or three more years will help tremendously."
The math is compelling. According to an analysis by T. Rowe Price, every year you postpone retirement adds about 7% to the retirement income you can eventually expect to earn from your investments. A 62-year-old who delays his exit from the work force until age 65 will see the income generated from his retirement account rise 22% (based on a salary of $100,000, a well-diversified portfolio worth $500,000 and 15% annual salary contributions); if he waits until 67, he'll get 39% more.
Staying on the payroll longer likely also means you'll be able to postpone drawing Social Security benefits. While you can collect starting as early as age 62, your benefits will be permanently reduced if you do; every year you delay between ages 62 and 70 adds 8% to your eventual payout. For example, someone who retires this year and qualifies for the maximum early benefit can collect $20,244. Put off drawing the benefit until age 70 and the annual payout will be $35,629 (in today's dollars).
Working longer is the wonder cure for a multitude of ailments that can imperil your retirement plan. It buys time for your portfolio to recover from the market's recent nosedive. And it helps keep health-care costs in check until you qualify for Medicare at age 65.
That's why Julius Roy is still behind the counter as a pharmacist in Slidell, La. at 60 and why he intends to stay there a few more years. Although Julius and his wife Diane, 64, also a pharmacist, have more than $1.6 million in their investment accounts, he doesn't want to give up his employer-provided health insurance. Having undergone double bypass surgery when he was 40, he figures he'd have a tough time qualifying for a private policy and might still face big expenses if he was hit by a major illness. "Staying at work a few more years to stay insured could make all the difference to my financial security in the long run," Julius says.
Friday, September 5, 2008
To get rich, start saving in your 20's part 2
Be aggressive with your investments Make sure to invest your money shrewdly. According to Hewitt, workers 18 to 25 typically invest 35% of their retirement savings in bonds. Yet bonds have historically returned 5.4% a year -- right around the risk-free rate and just ahead of inflation. That's practically sticking it in a jelly jar! Stocks, meanwhile, traditionally have grown at an annual clip of 10.4%, according to Ibbotson Associates, an asset allocation service that's part of investment ratings agency Morningstar.
Instead, play it aggressive, and put 90% of your investments in stocks, says Ellen Rinaldi, executive director of investment planning and research at mutual funds giant Vanguard. Stocks are interchangeably referred to as equities, since as a stockholder you own a slice of the company's value in the market, its equity.
"From an allocation viewpoint, someone in their 20s has a very long horizon, so they can handle the ups and downs of the market," says Rinaldi. "They can recover from a downturn. As a result, they should be heavily invested in equities."
You can hedge against the risk of loss by diversifying your investments. That's a fancy way of saying you want to own as many different types of stocks as possible, and it's a message that will hold true throughout your lifetime. That means steer clear of buying a single stock and look to mutual funds, a tradable vehicle made up of sometimes hundreds of different investments in widely varying quantities. They could be made up entirely of stocks, bonds, a combination of both or simply track the market by holding equal amounts of all shares in a given index, known as an index fund.
So-called lifestyle or life-cycle mutual funds make it especially easy for novice savers to buy a diversified array of stocks that are tailored to their age and retirement goals. That's because these funds are set up to automatically pick and choose the equities in the fund, and to rebalance those holdings over time, buying and selling shares in order to maintain the advertised mix of risk and return (or caution and predictability) by age bracket.
"Look for retirement funds targeted to your age bracket. They'll be much more aggressive for someone in their 20s," says Rinaldi. "If you just look for a balanced fund, you may wind up with 40% of your money in bonds, which is a typical mix for these funds."
Get educated Meanwhile, don't be embarrassed to admit that financial talk can seem confusing. After all, financial know-how is not genetically encoded and, unless someone has taken the time to teach you about finance, you'll need to do a little learning. And now that you're starting to make and save money, this is the perfect time to educate yourself.
More than a third of companies now offer employees access to advisers who can help choose investments that will be most appropriate, according to Hewitt. These advisers can explain what holdings are in a particular fund and why they'd recommend one investment over another. Read books, articles or financial Web sites. The more you know, the easier it will be throughout your career to make solid, informed decisions.
"I think the reality is most parents are more inclined to talk to their kids about sex education than talk to them about finance or saving for retirement," says Jones. "That's just not a conversation people have, so a little Finance 101 is probably a good idea."
Build a strong defense with an emergency stash What's next? Start amassing an emergency fund so you don't have to rely on credit cards -- and possibly bury yourself in debt -- in the event that your car dies, your roommate comes up short on rent or you suffer some other financial mishap. Ideally, you'll stash up to three months living expenses, but the important goal is to save something. You can help stay on track by having automatic deposits made to your emergency account.
In the meantime, keep an eye on spending. Those splurges can add up fast and will prove to be a huge drain on future savings. What's more, if you pile on debt, you'll wind up wasting a lot of money on interest and fees that could be better spent elsewhere.
Avoid debt If you're really struggling to stretch the paycheck to set something aside for retirement, this is the time to make some changes.
Give your budget needs a major overhaul. Consider getting a roommate or picking up an extra job for the time being. Big changes now, coupled with consistent saving over time, will reap huge rewards down the road, says Jones. He speaks from experience. Jones took a year off from college to work so he could pay off credit card debt. It wasn't easy but, he says, "I graduated debt-free."
Lamb has already seen how a little financial discipline reaps big rewards.
"Making my bills is my No. 1 priority before anything else. I don't buy new clothes. I cook at home. And I don't drink, which is a big money-saver. People go out and will spend $100 on alcohol in one weekend. I don't do that," she says.
Yet she does let herself have occasional "big purchases," like a house recently bought with her fiance.
"I really wanted one," she says. "And I made it my goal."
This article was reported and written by Leslie Haggin Geary for Bankrate.com.
Instead, play it aggressive, and put 90% of your investments in stocks, says Ellen Rinaldi, executive director of investment planning and research at mutual funds giant Vanguard. Stocks are interchangeably referred to as equities, since as a stockholder you own a slice of the company's value in the market, its equity.
"From an allocation viewpoint, someone in their 20s has a very long horizon, so they can handle the ups and downs of the market," says Rinaldi. "They can recover from a downturn. As a result, they should be heavily invested in equities."
You can hedge against the risk of loss by diversifying your investments. That's a fancy way of saying you want to own as many different types of stocks as possible, and it's a message that will hold true throughout your lifetime. That means steer clear of buying a single stock and look to mutual funds, a tradable vehicle made up of sometimes hundreds of different investments in widely varying quantities. They could be made up entirely of stocks, bonds, a combination of both or simply track the market by holding equal amounts of all shares in a given index, known as an index fund.
So-called lifestyle or life-cycle mutual funds make it especially easy for novice savers to buy a diversified array of stocks that are tailored to their age and retirement goals. That's because these funds are set up to automatically pick and choose the equities in the fund, and to rebalance those holdings over time, buying and selling shares in order to maintain the advertised mix of risk and return (or caution and predictability) by age bracket.
"Look for retirement funds targeted to your age bracket. They'll be much more aggressive for someone in their 20s," says Rinaldi. "If you just look for a balanced fund, you may wind up with 40% of your money in bonds, which is a typical mix for these funds."
Get educated Meanwhile, don't be embarrassed to admit that financial talk can seem confusing. After all, financial know-how is not genetically encoded and, unless someone has taken the time to teach you about finance, you'll need to do a little learning. And now that you're starting to make and save money, this is the perfect time to educate yourself.
More than a third of companies now offer employees access to advisers who can help choose investments that will be most appropriate, according to Hewitt. These advisers can explain what holdings are in a particular fund and why they'd recommend one investment over another. Read books, articles or financial Web sites. The more you know, the easier it will be throughout your career to make solid, informed decisions.
"I think the reality is most parents are more inclined to talk to their kids about sex education than talk to them about finance or saving for retirement," says Jones. "That's just not a conversation people have, so a little Finance 101 is probably a good idea."
Build a strong defense with an emergency stash What's next? Start amassing an emergency fund so you don't have to rely on credit cards -- and possibly bury yourself in debt -- in the event that your car dies, your roommate comes up short on rent or you suffer some other financial mishap. Ideally, you'll stash up to three months living expenses, but the important goal is to save something. You can help stay on track by having automatic deposits made to your emergency account.
In the meantime, keep an eye on spending. Those splurges can add up fast and will prove to be a huge drain on future savings. What's more, if you pile on debt, you'll wind up wasting a lot of money on interest and fees that could be better spent elsewhere.
Avoid debt If you're really struggling to stretch the paycheck to set something aside for retirement, this is the time to make some changes.
Give your budget needs a major overhaul. Consider getting a roommate or picking up an extra job for the time being. Big changes now, coupled with consistent saving over time, will reap huge rewards down the road, says Jones. He speaks from experience. Jones took a year off from college to work so he could pay off credit card debt. It wasn't easy but, he says, "I graduated debt-free."
Lamb has already seen how a little financial discipline reaps big rewards.
"Making my bills is my No. 1 priority before anything else. I don't buy new clothes. I cook at home. And I don't drink, which is a big money-saver. People go out and will spend $100 on alcohol in one weekend. I don't do that," she says.
Yet she does let herself have occasional "big purchases," like a house recently bought with her fiance.
"I really wanted one," she says. "And I made it my goal."
This article was reported and written by Leslie Haggin Geary for Bankrate.com.
To get rich, start saving in your 20's part 1
To get rich, start saving in your 20s
Even if money is tight, this is the time to start stashing away money. Start small, start now.
It's easy to understand why retirement doesn't loom large on the horizon for 20-somethings. Young workers are more concerned with kick-starting careers, not ending them in the long-distant future.
But it's worth noting that the very fact that you're young gives you a huge edge if you want to be rich in retirement. That's because when you're in your 20s, you can invest relatively little for a short period and wind up with far more money than someone older who saves much more over a longer period.
Consider this scenario: If you begin saving for retirement at 25, putting away $2,000 a year for just 40 years, you'll have around $560,000, assuming earnings grow at 8% annually. Now, let's say you wait until you're 35 to start saving. You put away the same $2,000 a year, but for three decades instead, and earnings grow at 8% a year. When you're 65 you'll wind up with around $245,000 -- less than half the money.
Seems like a no-brainer, right? Save a little now and reap big rewards later.
Unfortunately, many of today's youngest workers pass on the opportunity to save for retirement early, when the beauty of compounding interest can work its magic and maximize savings. A recent study by human resources consultant Hewitt Associates found that just 31% of Generation Y workers (those born in 1978 or later, now in the thick of their 20s) who are eligible to put money into a 401(k) retirement savings plan to do so. That's less than half of the 63% of workers between ages 26 and 41 who do invest in employer-sponsored savings accounts.
Start saving ASAP There are plenty of reasons you may have yet to save, such as cash flow. If you're struggling to pay off student loans or cover rent, funding a 401(k) may seem difficult if not downright impossible.
But be wary of letting expenses become an excuse, says Brian T. Jones, a certified financial planner and the author of "Getting Started: The Financial Guide for a Younger Generation."
"These years of saving in your early 20s are your prime years. If you deny yourself the opportunity, it will just set you back with retirement planning in the long run," says Jones. "You've got to have balance."
Sign up for that 401(k) Make the most out of those few dollars you can get hold of by allocating them wisely. Don't squirrel them away under the mattress. You will want them to be invested in a way that will encourage your assets to grow as quickly as possible.
Where to start? If you're eligible to participate in a 401(k) at work, do so. There are plenty of reasons to love these plans but No. 1 by far is that most employers match your contributions in order to encourage your participation. The hitch: Oftentimes, you'll need to save enough to trigger the match.
In a typical plan, employers match up to 3% of your salary, according to the Profit Sharing/401(k) Council of America. When you do sign up, the money you save will be automatically deposited into the plan before it's taxed, so less of your income will be taxed now. That saves you money, too.
That's what Rebecca Lamb has discovered. The 28-year-old Connecticut resident works in a nonprofit organization so she saves in a 403(b), which is similar to a 401(k) though they often don't allow company matching. These days, Lamb can't afford to plow huge sums into the plan, but she saves what she can. She also has a savings account that she opened when she got her first job at 15.
"I'm a disciplined person. I put in little amounts and save what I can. If it's $20, I put that in. If it's $100, I put $100. I've always done that," she says. "I'm just trying to save what I can right now. Hopefully, in years to come, I'd like to think I could put more way. But right now I'm just trying to save what I can because every little bit counts. I don't get caught up in the numbers."
No company retirement fund? Use a Roth instead If you aren't eligible for a retirement fund at work that gets you matching funds, sign up for the next best thing: a Roth IRA. You'll fund this with money that's already been taxed as part of your normal paycheck. But money in a Roth IRA withdrawn later is tax-free.
This year, you can put up to $4,000 in a Roth, but don't let that number scare you off if it seems far too rich for you today. Save what you can. It will add up. If you are able to sock away $4,000 a year into a Roth for 40 years, and if it earns 8% annually, you'll be a tax-free millionaire at retirement.
To make sure you stick to saving, have a portion of your paycheck or payments from your bank account automatically deposited into the Roth each month or every few weeks.
This article was reported and written by Leslie Haggin Geary for Bankrate.com
Even if money is tight, this is the time to start stashing away money. Start small, start now.
It's easy to understand why retirement doesn't loom large on the horizon for 20-somethings. Young workers are more concerned with kick-starting careers, not ending them in the long-distant future.
But it's worth noting that the very fact that you're young gives you a huge edge if you want to be rich in retirement. That's because when you're in your 20s, you can invest relatively little for a short period and wind up with far more money than someone older who saves much more over a longer period.
Consider this scenario: If you begin saving for retirement at 25, putting away $2,000 a year for just 40 years, you'll have around $560,000, assuming earnings grow at 8% annually. Now, let's say you wait until you're 35 to start saving. You put away the same $2,000 a year, but for three decades instead, and earnings grow at 8% a year. When you're 65 you'll wind up with around $245,000 -- less than half the money.
Seems like a no-brainer, right? Save a little now and reap big rewards later.
Unfortunately, many of today's youngest workers pass on the opportunity to save for retirement early, when the beauty of compounding interest can work its magic and maximize savings. A recent study by human resources consultant Hewitt Associates found that just 31% of Generation Y workers (those born in 1978 or later, now in the thick of their 20s) who are eligible to put money into a 401(k) retirement savings plan to do so. That's less than half of the 63% of workers between ages 26 and 41 who do invest in employer-sponsored savings accounts.
Start saving ASAP There are plenty of reasons you may have yet to save, such as cash flow. If you're struggling to pay off student loans or cover rent, funding a 401(k) may seem difficult if not downright impossible.
But be wary of letting expenses become an excuse, says Brian T. Jones, a certified financial planner and the author of "Getting Started: The Financial Guide for a Younger Generation."
"These years of saving in your early 20s are your prime years. If you deny yourself the opportunity, it will just set you back with retirement planning in the long run," says Jones. "You've got to have balance."
Sign up for that 401(k) Make the most out of those few dollars you can get hold of by allocating them wisely. Don't squirrel them away under the mattress. You will want them to be invested in a way that will encourage your assets to grow as quickly as possible.
Where to start? If you're eligible to participate in a 401(k) at work, do so. There are plenty of reasons to love these plans but No. 1 by far is that most employers match your contributions in order to encourage your participation. The hitch: Oftentimes, you'll need to save enough to trigger the match.
In a typical plan, employers match up to 3% of your salary, according to the Profit Sharing/401(k) Council of America. When you do sign up, the money you save will be automatically deposited into the plan before it's taxed, so less of your income will be taxed now. That saves you money, too.
That's what Rebecca Lamb has discovered. The 28-year-old Connecticut resident works in a nonprofit organization so she saves in a 403(b), which is similar to a 401(k) though they often don't allow company matching. These days, Lamb can't afford to plow huge sums into the plan, but she saves what she can. She also has a savings account that she opened when she got her first job at 15.
"I'm a disciplined person. I put in little amounts and save what I can. If it's $20, I put that in. If it's $100, I put $100. I've always done that," she says. "I'm just trying to save what I can right now. Hopefully, in years to come, I'd like to think I could put more way. But right now I'm just trying to save what I can because every little bit counts. I don't get caught up in the numbers."
No company retirement fund? Use a Roth instead If you aren't eligible for a retirement fund at work that gets you matching funds, sign up for the next best thing: a Roth IRA. You'll fund this with money that's already been taxed as part of your normal paycheck. But money in a Roth IRA withdrawn later is tax-free.
This year, you can put up to $4,000 in a Roth, but don't let that number scare you off if it seems far too rich for you today. Save what you can. It will add up. If you are able to sock away $4,000 a year into a Roth for 40 years, and if it earns 8% annually, you'll be a tax-free millionaire at retirement.
To make sure you stick to saving, have a portion of your paycheck or payments from your bank account automatically deposited into the Roth each month or every few weeks.
This article was reported and written by Leslie Haggin Geary for Bankrate.com
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