So I wrote this article to turn into a presentation for a couple speaking engagements I am doing. It turned out pretty good so, in keeping with my whole theme of “this stuff isn’t that hard, just keep it simple” i thought I would post it here.
It is long, so I am going to break it into three parts, so make sure to stay tuned:
The three tricks to retiring in any economy:
Clarity, Simplicity, Reduction of Risk.
Simple! These are the most important things you need to be focused on when thinking about retirement. Not how many stars a fund got from Morningstar, not what the past 10 years of yield have been on a particular bond, not on which insurance company has a + or – next to their rating.
Most of my clients are so confused by retirement because they are being overwhelmed with investment product information. So much so, that they forget that THEY are supposed to be the center of their retirement universe, NOT the investments.
Knowing what you have.
Most clients come to me with a mess. They have IRAs they opened years ago, a couple small 401(k)s, maybe an ETrade account. I even had a client that didn’t know that you could add money to an IRA, so when they went to open one each year at the bank, they opened a new account. At retirement they have 40 IRAs with between 5,000 and 10,000 in each one! When you ask them what their net worth is, they stare blankly. They don’t know if they can retire, because they don’t even know what they have, let alone what they can do with it. Clarity is the first step to a good retirement plan. Knowing what you have and what the goal of that money is allows you to sleep at night.
It should take no more than 5 minutes to see your entire net worth. In this day and age, there is no reason that you should not have the ability to view your financial information quickly and easily. But understanding how much you have in assets is only half the battle. More and more people are going into retirement with some sort of debt still: mortgages, credit cards, car loans, business loans, etc. Sometimes we tell people to pay their debt off ahead of time, sometimes we go into retirement with the debt, but not knowing about it makes it impossible to plan for. Having debt isn’t a non-starter for retirement, but NOT KNOWING can be. You have to have solid understanding of what the payments look like, over the entire life of your retirement, so you can plan for them and ensure that the money will be available to pay those debts.
It is also critical to understand your income streams. An income stream (like Social Security or a pension) are an asset, just like anything else. Many people dramatically underestimate the value of their pension. Did you know that if you wanted to buy the pension that a typical teacher gets at retirement, say, $50,000 a year at age 65, it would cost you more than $675,000? If you retired at 60 that number would be more than $760,000. That is a major asset! What about Social Security? The typical retiree gets about $1700 a month and that translates into an asset worth $275,000. That is an awfully big asset to throw away! Other people dramatically overestimate the value of a pension plan as well. If you underperform inflation by just 1% a year, in 20 years you will have lost nearly 20% of your purchasing power! Knowing what you have coming and how long it will last is critical, as it is easy to make mistakes on pensions. I once had a client, when offered his choice of payouts options at age 60, selected on of the highest amounts. He didn’t realize that this limited the time frame. Fast forward 15 years and now he is 75 and the pension STOPS! Without assets to replace that income, that could be a REAL problem.
Knowing what you need
Once you know what you have, you also have to know what you need. Before retiring, we are going to design an income stream to support your lifestyle. If the numbers work, you can retire comfortably. There are lots of ‘rules of thumb’ for how much income you need. But do you really want to bet your entire retirement on guessing what income you will need in retirement?
There are many big expenses that can come up in retirement. I once did a plan for a client. They were not wealthy, just typical middle class people. We did a great plan, and they had enough money to retire on a budget that they were comfortable with, with some extra ‘emergency’ money set aside for those unknowns in life. What they neglected to tell me during their planning phase was that they had told their three grandkids that they were going to help pay for college. They assumed that, because they had $500,000 in assets, that taking out 25 or 30k for wouldn’t be a problem. After all, what was $25,000 next 500k or even 750k? What they didn’t realize is that, taken together, that was 10% of their investments. Just because an account has money in it, doesn’t mean it isn’t doing anything. Those accounts were all being used to produce their income. So take 10% of it out, and they just gave themselves a 10% pay cut FOREVER. And it isn’t always big chunks like $25k or 30K. I have seen clients bleed themselves dry because their son or daughter got into trouble again and “just needs $4,000 or $5,000 to float them”.
When looking at retirement expenses, clarity is important. You need to make a budget. You need to clearly understand how much money you will have each month in retirement. Only then can you make decisions about whether or not you can or want to retire.
Ups and downs happen in life, retired or not. Any good retirement plan needs to take that into account. If you need every dollar you have to produce income, then you probably can’t retire. “Stress-testing” your plan is critical. Can you afford if the market is down 10%? What about 40%?