Myths Of Retirement Planning
I have received several financial plans over the last few weeks that have been prepared for individuals by CFP's and advisors that are fraught with a variety of financial mistakes. Unfortunately, most of these "financial plans" have been for the purpose of selling annuities. I wanted to go through some very basic concepts that you need to consider when planning for your retirement whether it is in 5 years or 25 years and more importantly dispel a lot of myths.
The Market Does Not Return 8% Per Year
One of the biggest mistakes that people make is assuming that the markets will grow at a consistent rate over the given time frame to retirement. There is a massive difference between compounded returns and real returns as noted in the chart. The end result of both series of numbers is an annual rate of return of 8%. However, in the "real return" column the returns have to be exceptionally high on a consistent basis in order to average out to the 8% compounded return - and returns like that don't happen to often. MOST IMPORTANTLY - while both sets of numbers grew at 8% - your money didn't.
This is one of the biggest mistakes that are made in financial planning which is NOT to include variable rates of return in your planning process. The draw downs on your principal investment are the most dangerous part of retirement planning.
Furthermore, do not choose rates of returns for planning purposes that are outside historical norms. Stocks tend to grow roughly at the rate of GDP plus dividends. Into today's world GDP is expected grow at roughly 4% or less in the future with dividends around 2% currently. The difference between 8% returns and 6% is quite substantial. Also, in order to achieve 8% in a 6% return environment you are trying to increase your return over the market by 33% - that requires you to on an astonishing level of risk to outperform the markets by that degree which means that the losses you will take when the markets correct will be outsized as well.
Plan for realistic returns in the future as well as adjust and account for market swings that will impact the ending value of your money.
Most Likely You Aren't Saving Enough
Here are some shocking statistics for you. The average salary in America is about $53,000 a year as per the US Census Bureau.
There are two things to take away from this chart. The first is that assuming your salary is going to rise until you retire is not a realistic assumption, except for potentially cost of living adjustments, as most of American workers cap out their earnings potential in their late 40's. The other statistic that goes along with this is that the average American has ONLY about ONE years salary saved up for retirement.
In order to effectively be planning and saving for your retirement you need to be saving 30-40% of your gross income and living on the balance. The order of savings is as follows
- Fully fund your retirement plan at work
- If you qualify - contribute to a Roth or Spousal IRA
- Save 1/2 of what you contribute to your retirement plan into an after tax investment/savings account
- Overfund a permanent life insurance policy
In reality, most Americans are woefully underprepared for retirement and are hoping that Social Security or their pension will provide the social safety net they need to make it through. There is a high probability that in coming years that the massive underfunded status of both of these programs will lead to less than expected results for retirees.
Retirement Is More Costly Than You Think
Most people that I see are running around with the idea that they can retire on 70% of their current income. In reality, this will leave you far short of the retirement dream that you are hoping for. In a recent survey of 5000 retirees the average difference between pre and post-retirement incomes was about 12%. The reason is that while your house may be paid off and your children gone at retirement - individuals tend to substitute other items that eat into the retirement budget such as picking up an expensive hobby like golf, traveling more, spoiling grandchildren but the biggest consumer of post retirement income comes from increased medical expenses and higher healthcare insurance costs.
To be safe you should be planning on 100% of your current income stream for retirement. If you aren't - you could find yourself coming up short and you don't want to find that out once you are already IN retirement.
Investing For Retirement
You cannot INVEST your way to your retirement goal. As the last decade has most likely taught you, hopefully by now , is that the stock market is not a "get wealthy for retirement" scheme. You cannot continue to under save for your retirement hoping the stock market will make up the difference. This is the same trap that pension funds all across this country have fallen into and are now paying the price for.
You must actually save money if you want to retire...period.
The financial markets are there for a reason and should be used - not as a "casino" or "get rich quick scheme" but as a tool to ensure that your SAVINGS have the same purchasing power parity in the future. In other words, your job as an investor, and mine as a portfolio manager, is NOT TO BEAT THE S&P 500 in any given year - your goal is ONLY to outpace inflation. Chasing an arbitrary index that is 100% invested in the equity market requires you to take on far more risk that you most likely want. This is why after the last decade individuals are still below breakeven and have lost a far more valuable asset than money - and that is the TIME that has been lost that is needed to prepare properly for retirement.
Investing for retirement, no matter what age you are, should be done conservatively and cautiously with the goal of inflation adjustment being the sole goal. You work very hard for your money - don't squander it by putting it at risk of loss. However, this doesn't mean that you will NEVER make money in the markets - the goal, however, should be not to lose as much in down markets (our rule at Streettalk Advisors is 80% of the upside and no more than 20% of the downside). Overtime, not beating the market on the upside, but conserving a large amount of the principal on the downside, will actually accrue to an out performance of the overall market and a successful landing at retirement.
- Blue chip dividend yielding stocks over speculative barn burners
- Fixed income over CD's
- Certain annuities can be useful for shoring up income needs at retirement (be very careful - these can be hazardous to your health if used improperly)
- Don't be afraid to hold a LOT of cold hard cash during times of market uncertainty.
Most importantly - turn off the media and don't look at your portfolio more than once a week. All you are doing by watching the markets tick by tick is driving yourself insane and trapping yourself into making emotional decisions on your investments which will, more often than not, turn out to be wrong.
5 Things You Need To Know
- There is no computer trading program that works - if there was Goldman Sachs would own it and they wouldn't share it with you. Anybody who is hocking some latest trading software is making money off you - if it worked they would be rich and wouldn't be selling it to you.
- You Will Be WRONG. No stock or investment goes up forever. More importantly, the higher they go up - the bigger the crash will be. RISK does NOT equal return. RISK = How much you will lose when you are wrong and you will be wrong more often than you think.
- Don't worry about paying off your house. A paid off house is great but if you are going into retirement house rich and cash poor you will be in trouble. You don't pay off your house UNTIL your retirement savings are fully in place and secure.
- In regards to retirement savings - have a large CASH cushion going into retirement. You do not want to be forced to draw OUT of a pool of investments during years where the market is declining. This compounds the losses in the portfolio and destroys principal which cannot be replaced.
- Plan for the worst. You should want a happy and secure retirement - so plan for the worst. If you are banking solely on Social Security and Pension Plans - what would happen to you if they weren't there. Corporate bankruptcies happen all the time no matter how big the company is. Yes, Wal-mart, Exxon and AT&T certainly can go bankrupt - it wasn't that long ago that people thought GM couldn't go bankrupt either. In the event of a bankruptcy, the pension plan goes to the Pension Benefit Guarantee Corporation which, since they are massively underwater, will most likely contact you with a reduced payout.
Bottom line: Plan for the worst - this way if ANYTHING else happens you are in great shape.
It's All About You & Your Money
As we say everyday on the show - it is all about you and your money. Pay attention to it and understand the difference between what is good for you and what is good for Wall Street. Wall Street wants you to chase the markets, insurance companies want you to buy products and gold companies want you to buy gold - why, because it makes them money - it doesn't mean that you will make money.
There is no one more concerned about YOUR money than you. Investigate, learn, ask questions and get involved. If you don't take an active interest in your money - why should anyone else?