Many adults are scared about retirement, they hear the gloomy projections on television and they may become paralyzed with ‘retirement anxiety.’ This fear can lead to a lack of retirement planning. Rest assured that regardless of your current age, a little planning can pave the way to a happy retirement.
The future retiree doesn’t need to spend many hours figuring out the perfect plan for the last few decades of life, nor should they do nothing and expect that retirement will ‘take care of itself.’ Here’s what savers should know and what their financial advisors should be preaching.
Step 1: Know the (Approximate) Number
There’s more than enough conversation about the retirement number. For a happy retirement, you need an estimate of approximately how much money you’ll need to live. An estimate or approximate ‘retirement number’ is adequate. A back of the envelope calculation suggests a projected 85% of your pre-retirement income will suffice in retirement. Depending upon your personal situation, you may need more or less.
Imagine that 45-year-old Gayle expects to earn $100,000 at age 67 and plans to retire at age 68. With these assumptions she might need $85,000 per year in retirement. But before blindly accepting that number, remember, taxes will fall and so will retirement plan contributions. And much of retirement planning revolves around the retiree’s activities and the cost of living in their geographic region. So, the $85,000 ‘number’ is an estimate.
After some thought and evaluation, Gayle concedes that $80,000 is a good retirement number estimate. Gayle expects to receive $40,000 from Social Security. So, she needs about the same amount from other sources. Gayle has a pension from a prior job which will pay an additional $10,000 per year in retirement.
Next she needs to figure out where the additional $30,000 will come from.
Step 2: Plan Your Financial Retirement Path
Let’s take a peek into Gayle’s workplace retirement account. Since age 30, Gayle has saved close to 10% of salary and her 401(k) account is worth $275,000 (this includes matching contributions from her employer as well).
According to our prior assumptions, in order for Gayle to fund an additional $30,000 dollars annually for her retirement, she’ll need about $753,440 saved at retirement according to a popular online calculator.
For this example we assumed that Gayle has 23 years until retirement and will live 25 years after retirement. With 2% inflation and 7% annual returns, she needs to build up an additional $478,440 by the time she’s age 68. The $478,440 is the difference between her current retirement account value of $275,000 and $753,440, the projected amount needed at retirement. (To add a cushion, we used $32,000 as the required annual income figure.)
Now she has the data to build her future retirement plan. If she saves $737 per month until age 68 and her investments return 7%, she will meet her retirement goals. This is less drastic than it seems as most workers today can count on a nice 5-7% employer match into the employees retirement account.
Although these calculations may take a few minutes now, the advisor has many tools to help the client with future retirement projections. After plotting out a course, the future retiree can feel confident that she’s on the right path.
Step 3: Invest Wisely
All the great projections are worthless if the inputs are wrong, and that’s why you want to use a conservative future rate of return estimate. With smart investing, and a knowledge of historical asset class prices, a reasonable future return can be predicted.
Over the last 80 to 100 years, stocks returned 8% to 9% annually and bonds approximately 5%. By dividing the client’s portfolio with 60% stock investments and 40% bonds, and assuming historical returns continue, 7% is a reasonable future projected return.
Resist the temptation to shoot for the moon with your investment products. Avoid speculative and risky investments promising higher than average returns.
Diversified and low cost mutual funds will get the investor to the finish line without the drama. Every investment goes up and down, but consistent investing through market ups and downs will most likely yield solid investing results.
Step 4: Monitor and Evaluate Periodically
A colleague says he checks his investment portfolio return daily. That is a great way to push an investor over the edge. With an investment portfolio, you receive returns that are higher than those from a savings account. But the price you pay for the higher returns is asset values that bounce around a bit, especially in the short term.
In a video viewed many years ago, John Bogle, founder of The Vanguard Group, recommended checking your portfolio when you retire. That may be a bit too infrequent. Yet, there’s no reason to check your investment portfolio more than quarterly. The more often you check your investments, the more you may be tempted to take action. Frequent trading leads to under performance, as active traders typically sport subpar returns.
Once per year it’s preferable to rebalance your investments back to the asset allocation you selected at the beginning of the year. More investment portfolio tinkering is ill advised.
Credit: By Barbara A. Friedberg, Investopedia
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