Even the greatest golfers sometimes find themselves in tall grass or deep water. Yet they often find a way to make the best of it, using a skillful short game to chip and putt their way to pars, birdies — and victories.
So it is with retirement planning, as well.
Over the course of several decades, it's virtually inevitable that some financial goals will miss the fairway. Maybe you teed off too late, ran into turbulent markets or suffered unexpected economic setbacks.
But as the time to retirement grows shorter, making the best of any setbacks requires the thoughtful “course management” skills of a champion golfer.
Planning for longer
Wishes for life's Golden Years are as varied as the people who yearn to make them happen. What doesn't vary, however, is the implacable reality that without sufficient savings, few retirement dreams will come true.
In part, that's because we're living longer, so our money needs to last longer.
Since 1970, the amount of time a person can expect to live in retirement has increased by about one-third.1 The average American male now is projected to live another 17.5 years after reaching the traditional retirement age of 65, while female longevity will average almost 20 years from that stage of life.2
Not surprisingly, though, the Great Recession took a severe toll on how Americans expect those extended retirement years to play out.
According to one study, the financial crisis shaved the median net worth of baby boomers (those born in the two decades after World War II) by about 25%.3 Since later boomers are nearing the end of their working years — some already are retired — they'll have less time to make up lost ground.
Though Generation X (born 1966 to 1975) has more catch-up time, they took an even bigger hit, losing close to half their wealth between 2007 and 2010.4
Even with a recovery in stock and house prices, deep financial scars remain.
As of this spring, the average U.S. household had recovered only 62% of the inflation-adjusted wealth lost to the downturn.5 Americans are still $4.3 trillion short of the amount they'll need to maintain their current lifestyles in retirement.6
Most future retirees know they'll need to invest more — and perhaps work longer.
In 1993, 21% of workers said they had what they needed to retire, a number that peaked at 27% in 2007. As of early this year, however, only 13% expressed such optimism, while nearly half either didn't know or weren't at all confident.7 Medical and long-term care expenses were a main source of their worries.8
And with good reason.
It's estimated that one-third to one-half of Americans aged 65 or older eventually will need long-term care at a price tag that could approach $100,000 per year.9 And since Medicare covers only about 51% of health-related costs, a couple aged 65 and retiring in 2013 can expect to spend close to a quarter of a million dollars just on health care over the remainder of their lives.10
All of which makes pursuing sound investment strategies even more critical, both during and in the lead-up to retirement.
“Regardless of your age or circumstances, investing in a regular and prudent manner always is important,” said Susan Czochara, a senior product manager in the Defined Contribution Solutions group at Northern Trust. “But it's even more vital in the 10 to 15 years prior to retirement. There's less time to make up for mistakes in not saving sufficiently or poor-performing markets.”
Besides compensating for ground lost to the 2008 credit crisis, restoring a retirement portfolio could be further complicated by changes to Social Security and Medicare, and by the gradual end to the Federal Reserve's third round of monetary stimulus.
Financial markets grew choppy after Federal Reserve Chairman Ben Bernanke said in May that normalizing interest rates could begin sooner than expected.
So with volatility on the rise, but the need to invest for retirement more pressing than ever, here are few approaches to help you stay on track:
Diversify. Yes, it's a cliché of sorts, but having exposure to several major asset classes in the United States and abroad might dampen risk and volatility. Besides the traditional “Big Three” of stocks, bonds and cash, investors could gain additional diversification through global real estate, commodities, and subsectors within each asset category. “Multi-asset class vehicles, like the Northern Global Tactical Asset Allocation Fund, help investors achieve broader, globally diversified exposure within a single fund,” said Jim Danaher, managing director of Northern Trust Defined Contribution Solutions. “That allows the investor to focus on the really critical issue of how much to put away for retirement, ideally on a monthly basis.” Some Northern Funds provide additional diversification though multi-manager structures in which several managers, each employing a different strategy, are combined in an effort to provide an attractive combination of risk and return and reduce volatility without sacrificing performance over the longer term.
Rebalance. The various markets rarely move in lockstep, so even an appropriate asset allocation decision eventually will be outdated. For instance, a portfolio with a 60-40 split between stocks and bonds in January might be significantly out of balance by June or July. Of course, taxes should play a role in how often it makes sense to “rebalance,” or bring your asset allocation ratio back to the desired weightings. But for funds held in a tax-deferred retirement account, like a defined contribution (DC) plan or IRA, it's often a good idea to restore a portfolio's equilibrium at least once a year. Yet Danaher estimates that only about 5 to 7% of participants in DC plans rebalance their portfolios that often.
Dollar-cost average. If your cash flow allows, try to put a fixed dollar amount into each of your funds every month or quarter. You'll be buying more shares when prices are low and fewer shares when prices are high — and removing emotion from the process. Achieving dollar-cost averaging is especially easy to accomplish through an employer's DC plan. Many such plans offer Northern Funds, including some that automatically shift the asset mix according to the investor's target retirement date.
Match game. It's always nice to invest with someone else's money. This is what happens when your employer offers to match all or a portion of your investment through the firm's DC plan. “Your first priority in investing for retirement should be to maximize the benefits of an employer match,” said Czochara. “If you pass up that opportunity, you're leaving money on the table.”
Protect against inflation. Sharp increases in the cost of living are among the most insidious forces undermining retiree finances. And though inflation is mostly dormant at the moment, it's a good bet that consumer prices won't be so well behaved in the future. That's because some economists believe that all that money created out of thin air as part of the Federal Reserve's three quantitative easing programs could cause inflation to revive as the economy does. Equities, real estate, commodities and Treasury Inflation-Protected Securities (TIPs) are generally considered effective hedges against moderate inflation.
Keep a long-term perspective. It's a fact of investing life that achieving long-term gain involves accepting some degree of short-term risk. Yet trying to guess short-term market swings usually is counterproductive. So think of the daily financial headlines — whether they are hopeful or doleful — as extraneous noise that shouldn't impact how, or how much, you invest.
A key question in retirement planning is the amount of income you'll need to keep the same pre-retirement lifestyle. The time-honored rule of thumb has been 80 to 85%, figures that Danaher and Czochara believe are still valid for many families.
Because of the positive effects of compounding, however, beginning an investment program early will make funding an 80% replacement ratio easier to attain.
According to one long-term study, American workers seeking to replace 50% of their final salary (with Social Security providing the other roughly 30%) needed to invest about 16.6% of their annual earnings each year for 30 years, assuming a 60-40 stocks-bonds split. But the size of the yearly contribution dropped to just 8.8% of earnings if it happened over 40 years.11
Yet, statistics show only early baby boomers (those born from 1946 to 1955) are on track to fund the desired 80% replacement ratio. Barring a jump in their savings rate and investment results, late boomers will be able to replace only about 60% of their pre-retirement income, and Gen-Xers just 50%.12
Of course, no one can turn back the clock for a do-over, so whatever your age, Danaher has a simple message: “It's never too late to start investing for retirement,” he said. “The key is to commit yourself to making those 'catch-up' contributions.” Danaher noted that participants in 401(k) plans aged 50 and older are allowed to make pretax “catch-up” contributions of up to $5,500 per year.13
It's also important to know the percentage of your savings that can be withdrawn and still have it last through a retirement stretching a quarter-century or more.
Traditionally, many financial planners thought that taking out 4% per year usually would keep retirees from outliving their savings.14 In that scenario, pulling $40,000 annually from a $1 million portfolio might be expected to last long enough.
Now, however, there are concerns that the so-called 4% rule might be too generous. If financial markets are heading into a period of subpar returns — a very big if, indeed — a safer withdrawal rate might be closer to 3%.
The sequence of returns also matters.
If financial markets perform well during the early years of retirement, the withdrawal rate could be nudged higher, perhaps to at least 5%.
Conversely, poor early returns could make even a 3% withdrawal rate too high without dipping into the principal — or your family's inheritances.
The bottom line: No one can say with certainty what a “safe” withdrawal rate will be. Every person's situation and objectives are different. Plus, the 4% formula is based on history, and no two 30-year periods ever have been identical.
With so much uncertainty, Danaher advises clients to keep focused on the three aspects of retirement planning that are well within their control.
“Save more, spend less and invest wisely,” he said. “Doing these three things, on a consistent basis, will yield a better financial outcome at retirement.”
Words to live by, whether you're teeing it up on the first hole or enjoying life's back nine.
Past performance is no guarantee of future results.
Diversification does not guarantee a profit nor protect against a loss.
Dollar-cost averaging does not insure a profit and does not protect against loss in declining markets. An investor should consider his or her financial ability to continue making additional investments through periods of low share price levels.
Asset Allocation Risk: An asset allocation strategy does not guarantee any specific result or profit nor protect against a loss.
Equity Risk: Equity securities (stocks) are more volatile and carry more risk than other forms of investments, including investments in high-grade fixed income securities. The net asset value per share of this Fund will fluctuate as the value of the securities in the portfolio changes.
Interest Rate Risk: Increases in prevailing interest rates will cause fixed income securities, including convertible securities, held by the Fund to decline in value.
International Risk: International investing involves increased risk and volatility.
1 “The High Price of Living Longer.” Julie Segal. Institutional Investor.com. November 2012
2 “The High Price of Living Longer.” Julie Segal. Institutional Investor.com. November 2012
3 “Retirement Security Across Generations.” The Pew Charitable Trusts. May 16, 2013
4 “Retirement Security Across Generations.” The Pew Charitable Trusts. May 16, 2013
5 Federal Reserve Bank of St. Louis. June 6, 2013
6 “The High Price of Living Longer.” Julie Segal. Institutional Investor.com. November 2012
7 Retirement Confidence Survey, 2013. Employee Benefit Research Institute
8 Retirement Confidence Survey, 2013. Employee Benefit Research Institute
9 “Planning for Retirement? Don't Forget Health Care Costs.” Paul Sullivan. The New York Times. October 5, 2012
10 “Planning for Retirement? Don't Forget Health Care Costs.” Paul Sullivan. The New York Times. October 5, 2012
11 “Saving for Retirement: The Wrong Number.” The Economist. July 21, 2011
12 “Retirement Security Across Generations.” The Pew Charitable Trusts. May 16, 2013
13 Northern Trust
14 “4% Rule for Retirement Withdrawals Is Golden No More.” Eilene Zimmerman. The New York Times. May 14, 2013