Even when markets are in turmoil and gas prices are soaring, it’s important to return to a basic theme: Americans need to do a better job of preparing for retirement. After reviewing fresh statistics on the topic, I can’t help but think that we are paying for the sins of the past two buoyant economic decades in spades right now.
Think about it: first the stock market roared higher, then the housing market exploded, both of which masked a fundamental problem—Americans got out of the habit of living within their means and saving. Compounding matters, a large swath of folks piled on loads of debt, making an already problematic situation dire. As the credit crisis and housing collapse continue to unfold, the long term effect is gripping the national retirement picture and payback is approaching.
Consider these facts that were recently released:
-28% of workers age 55 and over have less than $100,000 in total savings and investments (Employee Benefit Research Institute)
-Only 47% of workers have tried to calculate how much they will need in retirement (EBRI)
-43% of surveyed workers GUESS at how big a nest egg they will need, while 19% seek the assistance of a financial adviser and another 19% calculate their own estimate (EBRI)
-7% of workers are saving the maximum amount allowed in their 401 (k) plans (Financial Engines)
-18% of workers borrowed from their 401 (k) plan in 2007, versus 9% in 2005 (Boston College Center for Retirement Research)
Considering that the average Social Security benefit for retired workers is $1200 for men and $900 for women, many are facing an uphill battle when it comes to retirement --- and the problem is likely to escalate until Americans change their behavior. Wally from Cranston, RI, my favorite radio listener (and frequent contributor of excellent ideas) offered a simple formula that I have tweaked a bit to help people quantify the retirement challenge: WPK+BA+P/A=DR.
To spell it out: work place 401(k)/403(b) 457 plans + brokerage accounts + defined benefit pensions/annuities = delightful retirement. Work towards maxing out your retirement plan first, then add to brokerage accounts if cash flow allows, although for the majority, step #1 will be hard enough. If you are lucky enough to have a defined benefit plan, then there is a bit of icing on the cake. Payback is never easy-let’s get going!
Showing posts with label Retirement. Show all posts
Showing posts with label Retirement. Show all posts
Tuesday, June 17, 2008
Thursday, November 15, 2007
Three Paths
Most investors wish that they could be on a merry-go-round, not a roller coaster. Of course we know that it is not possible, but consider three different portfolios that are invested over an eight-year period.
Path #1 Path #2 Path #3
YR 1 10% 38% (22%)
YR 2 10% 23% (12%)
YR 3 10% 33% (9%)
YR 4 10% 29% 21%
YR 5 10% 21% 29%
YR 6 10% (9%) 33%
YR 7 10% (12%) 23%
YR 8 10% (22%) 38%
It’s hard to believe, but the compound annual return of each portfolio is exactly the same --- 10% for all three portfolios! Obviously Path #1 would be nice, but again, just not going to happen. Yet people consistently set themselves up for disappointment by expecting the historic “10% return” to occur year after year, only to discover that most years it’s not 10% on the nose.
Considering that we all have to endure variability of returns, which is better, Path #2 or #3? You may think that Path #2 isn’t so bad, but if you have retired at the end of year 6, it’s pretty darned painful, and it is similarly difficult to begin retirement with three nasty, down years. The one nice thing is that if you are still saving for retirement, the three down years allow you to invest in your retirement account at lower levels.
But what would happen if you were already retired in all three paths? In that case, most people would be withdrawing money from their accounts. So if the portfolio in each path is worth $1,000,000 and you are planning to withdraw an inflation-adjusted $50,000 each year, you may be surprised to see what would happen over the course of the eight years. In Path #1, after eight years, the $1million portfolio would be worth $1.6 million, in Path #2, it would be worth $1.8 million and in Path #3 it would total $1.2 million. A $600,000 differential is pretty major!
The reason that I bring this up is that when you are about to retire, rarely do results move in a straight line. Your job is to ensure that regardless of market performance, you are taking into account the various outcomes that would impact your life.
Path #1 Path #2 Path #3
YR 1 10% 38% (22%)
YR 2 10% 23% (12%)
YR 3 10% 33% (9%)
YR 4 10% 29% 21%
YR 5 10% 21% 29%
YR 6 10% (9%) 33%
YR 7 10% (12%) 23%
YR 8 10% (22%) 38%
It’s hard to believe, but the compound annual return of each portfolio is exactly the same --- 10% for all three portfolios! Obviously Path #1 would be nice, but again, just not going to happen. Yet people consistently set themselves up for disappointment by expecting the historic “10% return” to occur year after year, only to discover that most years it’s not 10% on the nose.
Considering that we all have to endure variability of returns, which is better, Path #2 or #3? You may think that Path #2 isn’t so bad, but if you have retired at the end of year 6, it’s pretty darned painful, and it is similarly difficult to begin retirement with three nasty, down years. The one nice thing is that if you are still saving for retirement, the three down years allow you to invest in your retirement account at lower levels.
But what would happen if you were already retired in all three paths? In that case, most people would be withdrawing money from their accounts. So if the portfolio in each path is worth $1,000,000 and you are planning to withdraw an inflation-adjusted $50,000 each year, you may be surprised to see what would happen over the course of the eight years. In Path #1, after eight years, the $1million portfolio would be worth $1.6 million, in Path #2, it would be worth $1.8 million and in Path #3 it would total $1.2 million. A $600,000 differential is pretty major!
The reason that I bring this up is that when you are about to retire, rarely do results move in a straight line. Your job is to ensure that regardless of market performance, you are taking into account the various outcomes that would impact your life.
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