Friday, May 3, 2013

Inadequate Retirement Account (IRA): Investing After You Retire

Note: This is the sixth and final installment of a series of posts with advice for the 90%-plus of American households that haven’t been able to save enough for retirement. The first post was Inadequate Retirement Account (IRA).

My feelings about post-retirement investment strategies (and for the decade prior to retiring, actually) for households who haven’t saved enough are based on four principles:

1.        If you weren’t able to save enough and invest successfully enough for retirement over three decades that featured the greatest bull market in history — while you were earning an income and not withdrawing from your portfolio — then it is unlikely that your previously unsuccessful investing skills are going to come to your rescue now.

If you found it difficult to accumulate wealth while you were working and adding savings to your portfolio constantly, you’ll find it tremendously harder to grow wealth with no additional savings coming in and constant withdrawals (spending) going out. To add to the pain, most economists forecast lower stock market growth ahead.

Over the past thirty years, you were in a sailboat with a strong, accommodating breeze. After retirement, you’re sailing into the wind and taking on water. There’s a world of difference.

2.        You should never, at any age, invest money in the stock market that you cannot afford to live without, because you may well end up having to.

You can lose money when you’re young and accumulating wealth without it having an impact on your standard of living. Losing wealth after you retire often means a permanent reduction in your standard of living. This is money you cannot afford to lose.

3.        William Bernstein says that after you win the retirement savings game, you should stop playing. I would add that once it becomes obvious that you can’t win, you should stop losing.

It takes a lot of stock market growth to improve your standard of living. One dollar of income per year for thirty years costs around $22. If you have minimal retirement savings, doubling that amount in the stock market probably won’t have a big impact on your standard of living, but losing half of it may.

The Bernstein recommendation is that you not risk losing your already-adequate retirement portfolio in a market crash just before you retire, as many households did in the 2007-2009 market crash.

4.        Retirees should first secure income to cover their non-discretionary spending needs, then set aside an emergency fund, and only then should they consider investing in the stock market.

Many economists recommend a “Floor and Upside” strategy, also known as the “Theory of Life-Cycle Saving and Investing”. In part, that theory recommends that you secure your non-discretionary retirement spending with safe investments (like government bonds) before investing what’s left over in riskier assets like the stock market.

In other words, when you go to Las Vegas, set aside enough cash for dinner and a plane ticket home and don’t bet from that stash. (Economists do, I confess, state this more eloquently.)

Retirees with inadequate savings, by definition, don’t have enough assets to secure a “floor” of spending that would let them live like they did before retiring, let alone having some left over to take to the casino.

When I consider my four principles, I conclude that retirees in this group should not invest any sizable portion of their wealth in stocks.

If you decide that you simply must bet on a better standard of living in the stock market — and I hope you don’t — then limit stocks to 40% or 50% of your portfolio at most and invest in low cost index funds. At least give yourself a fighting chance.

Ultimately then, my advice for households that have inadequate savings for retirement is:

·       Invest little or none of your savings in stocks after retirement
·       Begin investing less in the market about ten years before you retire
·       Make sure you have the equivalent of a couple of years of expenses saved in liquid assets for emergencies
·       Lastly, invest any additional savings in TIPs bonds and/or lifetime fixed annuities to generate a floor of secure income as best you can.

I realize that there are no attractive alternatives for safe income in the current environment, and that includes fixed annuities and TIPs bonds, but that won’t last forever. You have two choices in the meanwhile: take more risk or accept about zero percent interest for a while. Since zero gain is better than a loss, I’d wait. Keep your money in money market funds or short duration government bond funds until rates go back up.

So ends my six-part series of posts of retirement advice for the 90%-plus of American households who have been unable to adequately save for retirement. If you have lots of savings, then you have lots of options, but that’s usually the way things work, isn’t it?

That doesn’t mean there’s nothing you can do if you haven’t saved enough. In fact, it makes your decisions more critical. In a nutshell:

·       Work longer
·       Spend less
·       Manage your home equity and mortgage
·       Maximize your Social Security benefits, and
·       Don’t expect the market to save you.

How much difference can these decisions make? I ran a scenario through E$Planner Basic that consisted of a single male, age 60, who earns $50,000 a year and contributes 6% to his 401(k). His company matches 3%. He could retire at age 63 with a $12,708 per year standard of living. He could increase that amount 31% to $16,644 if he could work to age 66.

He could increase his standard of living 83% to $23,220 per year if he could work to age 70, but not many workers will be able to hold onto their job that long.

As someone commented on my last post, finding a competent, fee-only financial planner to help might be a great investment unless you're really good at these kinds of calculations. We're talking about tens or hundreds of thousands of dollars over your lifetime and you really need to get the decisions right the first time.

One last piece of advice: don’t beat yourself up if you haven’t been able to save the hundreds of thousands of dollars needed to maintain your standard of living after you retire. Fewer than one out of ten American families did.

Just make the best of it.

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