Good news: We’re living longer.
Progress in medicine and science is wonderful, but it means that we need to be more serious about retirement planning.
Even if we retire at the “traditional” age of 65 or 67, many of us will enjoy 30 or more years of retirement. And we need to fund these years ourselves.
Most of us won’t receive pensions. We need to invest wisely to be ready for retirement. What can you do to position yourself for a comfortable, long and rewarding retirement?
It’s Not About The Lump Sum
Don’t over-emphasize the amount of money that’s in your portfolio on Retirement Day.
Focusing on “The Number” is simplistic. The more important question is: How much income can you expect to receive annually? Can you sustain this over a potentially — hopefully! — long post-retirement life?
Think through your game plan. How much do you earn annually? One rule-of-thumb holds that you will need to replicate at least 80% of your pre-retirement annual income for a comfortable retirement. That number could be higher if you have more ambitious plans, such as leaving behind a large legacy for your family or establishing a charitable foundation.
Here’s a second rule-of-thumb: Look at your current spending, rather than your current income. Then craft a strategy around replicating that level of income during your retirement. (This rule-of-thumb is handy for people who spend substantially less than they earn.)
Your annual earning during retirement will largely be a function of six qualities: three growth contributors and three headwinds.
The Growth Drivers
1. Annual Contributions
How much are you able to contribute to your retirement each year?
Before you answer “not much,” review the discussion above — the one about longevity. The sooner you start saving — and the more you put away — the better your chances of getting to that $100,000 per year retirement marker (or whatever the right amount is for you).
Can you cut out expenses from your monthly budget, and place those savings in your retirement funds? Are you making full use of your employer’s 401(k) plan? If not, you should do everything in your power to maximize your employer match. That’s about the closest thing to a “gift” that exists in the world of modern retirement.
2. Investment Returns
The second source of growth are your investment returns.
When you think about returns, consider real spending power. Inflation is a fact of life. It’s been pretty tame for awhile now, but it will likely be back one day. Your annual returns should outpace inflation in order to preserve your future spending power. Think of your rate of return in terms of “CPI + X,” where X relates back to your game plan: how much you think you will need each year during retirement.
Bear in mind that your achievable returns will change over time. As you age, your goal will switch from growth to income. That’s one of many reasons why its important to get an early start: you can take advantage of the growth years when you have a higher risk tolerance.
The flip side to returns is the risk you accept when investing in different asset classes. We’ll talk about the risk element below, in the “Headwinds” section.
3. Supplemental Income Sources
Don’t forget about other sources of income. Maybe you stand to inherit money. Maybe you have income from rental properties or royalties.
While Social Security by itself is not enough to support a comfortable retirement, it’s a real source of income. Include it within your planning.
The Headwinds
1. Key Risks
Investments come with many different flavors of risk. For retirement planning purposes, the two most important risks to take into account are inflation risk and market risk.
We have already talked about inflation risk — you need to make sure your returns hold a good chance of outperforming inflation over time.
Market risk is not something you can control: asset markets are notoriously volatile and its hard to predict with any confidence the timing and magnitude of potential drawdowns. But you can take steps to control risk exposure. Diversify across asset classes with different characteristics (such as equities, bond funds, and more) so that you are not overexposed to concentrated risks.
2. Taxes
Taxes take a big bite out of your investments. Invest tax-optimally. Tax considerations shouldn’t drive your investment decisions, but you should minimize taxes wherever possible.
If you have a mix of tax-advantaged plans (e.g. 401k or IRA plans) and taxable investment accounts, use the tax-advantaged accounts for assets with higher tax triggers. These tend to be income-oriented assets like interest-bearing bonds, preferred stock and high-dividend common stock.
Also, keep an eye out for funds with high levels of asset turnover. High turnover can generate short-term capital gains, which are taxed at a higher rate than long-term gains.
3. Fees
The third headwind is fees. Numerous studies show that there is no meaningful benefi to investing in funds with higher fees and expenses. When it comes to investments, paying top dollar is not a predictive indicator of high quality.
Passive vehicles like exchange-traded funds (ETFs) or index funds cost less than actively-managed funds. It’s probably a good idea to err on the side of these lower-fee alternatives.
Seek Expert Advice
Finally, ask for help. Smart investing requires a familiarity with concepts that aren’t intuitive to most people.
Fortunately, there are services that can provide not only the knowledge, but also practical, step-by-step action plans for crafting a retirement strategy based on your specific goals and circumstances.
An online service like Jemstep provides expert advice and recommendations. It will project your future income stream — not just a lump sum but an annual income projection — based on your assumed contributions, financial goals, risk tolerance, mix of qualified and taxable accounts, and other relevant considerations.
Retirement is a marathon. It’s time to get in shape for the long road ahead.
Want expert advice on how to manage your retirement portfolio? Visit Jemstep.