Hi all. I hope you’ve been well. Sorry things have been quiet around here for a few weeks. As I’m sure you know, the markets have been kind of crazy this year and most of my time has been spent on the phone or in meetings with clients. Between that, annual reviews and an unexpected trip to Australia (more on that in another post), I haven’t had much time to write.
With that said, what the heck is going on with the markets?!? And what, if anything, should you be doing about it? Here’s a quick summary:
The Chinese economy has been slowing. Why? Several reasons. The population is aging. The Chinese currency—the Yuan—is overvalued and making their exports less competitive. Debt in China has skyrocketed. This last point is likely the most significant. Much of the debt in China was used to fuel their breakneck expansion and to meet their predetermined (i.e. not demand driven) GDP targets. This has resulted in no shortage of questionable investments and misallocated capital. I saw this first hand when I was in China several years ago. The skyline was dotted with construction cranes, but enormous new buildings sat empty. Countless high-rise apartments were built regardless of the fact that most Chinese couldn’t afford to live there. Highways, bullet trains and even entire cities were built without much concern for whether or not they were necessary. The fear is that many of those loans will never be repaid and will eventually put a significant strain on the Chinese banking system. The government is trying to engineer a soft landing, but the jury is still out on whether they’ll succeed. In the meantime, the economy is slowing and Chinese demand for commodities has dropped dramatically, which leads me to Point 2.
By some estimates, China consumes about half of the world’s commodities. As their economy slows, their demand for things like copper, steel and especially oil has dropped significantly. Add to that OPEC’s decision to open the floodgates and Iran finally pumping oil after decades of sanctions and commodities have been in free fall. This is generally good for the consumer, because gas is cheaper, but bad for many others (e.g. oil companies, employees at those companies, stockholders of those companies, banks with energy related loans, high yield bondholders, oil producing states like Texas and North Dakota, and countries that are heavily energy export dependent like Brazil, Venezuela, Canada and Russia).
Too much debt is never a problem. Until it is. Most people probably think we have less debt in the system now than we did during the 2008 financial crisis. After all, those bad home loans were mostly written off, Europe smacked Greece into shape and consumers and businesses shored up their balance sheets, right? Um, no. Unfortunately, China isn’t the only one that has piled on debt. Debt is higher now in every category—household, corporate, government, financial—than it was in 2007. The latest numbers I could find put debt $57 trillion (with a “T” like The Titanic) higher than in 2007. That’s a big gain in a short period of time and it has investors nervous. Confidence greases the gears of the global financial system. If lenders lose confidence in borrower’s ability to repay, things get dicey.
From the “what will they think of next” file, many Central Banks around the world have started adopting negative interest rates. That’s right, zero apparently wasn’t low enough. Now they’re moving to negative. ZIRP (zero interest rate policy) has given way to NIRP (negative interest rate policy) in countries such as Denmark, Sweden, Switzerland and Japan. The logic is to force banks to lend, weaken currencies to help exports and stimulate economies. Not surprisingly, there are a lot of people who think these policies could come with some pretty significant unintended consequences. This uncertainty has only added to the volatility.
Result: Market Volatility
Markets HATE uncertainty and all of the above have combined to give investors a heaping dose of it. Not surprisingly, most markets around the world are off to a rough start this year with 10-20% drops the norm. But don’t panic. If you go back through the archives at IR, you’ll see that I write an article like this one about once a year. The causes of the volatility change, but not the regularity. So you don’t want to overreact, but you do want to be defensive and make sure that your plans stay on track. The goal is to protect your retirement. As I’ve said many times before, the best way to do that is to Focus on Things You Can Control. That means things like asset allocation, security selection, debt, savings and cash to minimize sequence risk. Focus on those things and this too shall pass.
To a large degree, happiness is being able to do what you want when you want. To get to that point, however (and here’s the paradox), you often have to do what you don’t want when you don’t want. Case in point: Retirement.
All of that is still true, but I want to give you a quick reminder.
You still need money.
I didn’t say that retirement was not a math problem or that money had no role to play. (see this, this and this for articles on preparing financially). Instead, I said “more than.” In other words, it’s money plus something else. Money plus meaning.
Why the reminder? I got an email from a reader named Patricia recently that discussed this very topic. Here’s a brief excerpt:
“I am one of those people who deferred. I worked really hard for 30+ years, saved like hell, deferred life in many ways so we would be able to retire early. And according to you, I totally screwed up.”
First off, there are many things that fall under the category of “screwing up” in my opinion, but working hard and saving so you can retire early is not one of them. Hat tip to Patricia (she and I had a nice conversation via email) and anyone else out there who is doing what it takes to build a nest egg and achieve financial independence.
Second, I took Patricia’s email seriously, because if she felt that I was somehow disparaging the savers and deferrers (is that a word?), then others of you may have had that feeling too. Nothing could be further from the truth. Hard work and disciplined saving is absolutely critical if you’re going to meet your retirement goals. That said, the money without the meaning is pointless just like the meaning without the money is often unrealistically out of reach. It’s up to each of you to balance those competing interests in a way that works for your life and goals.
In 8 Habits of Successful Retirees, I told you to live with a sense of urgency (#1), retire to something, not from something (#4) and choose yes over no (#6). Just don’t forget Habit #5: Retire based on your bank account, not your birthday. Run after the meaning, just don’t forget about the money.
On Monday morning my friend texted me: “Holy cow! Don’t jump!” He was referring, of course, to the 1000+ point drop in the Dow. Thankfully, after more than 20 years in this business, I’ve gotten used to wild swings, so I wasn’t on the ledge (although in 2008 I was glad I work in a one story building). That said, volatility in the market can produce much fear and anxiety, especially if you’re at or near retirement. There is a 100% chance that market volatility will continue, so here are 5 things I’ve learned after two decades of bulls and bears that can help you keep your retirement plans on track.
Markets have recovered from every single downturn in history. Every. Single. One. The Panics of 1893, 1896, 1901 and 1907 (Seriously, calm down already!). The Crash of 1929. The recession of 1937-1938. The Flash Crash of 1962. Black Monday in 1987. The crash after Iraq invaded Kuwait. The 1997 crash caused by the Asian currency crisis. The Dot-com bubble in 2000. The crash after the September 11 attacks. The selloff in 2002. The financial crisis of 2007-2009. The Flash Crash in 2010. The markets are higher now than after every panic, bubble, crash and crisis in history, but be careful because…
You are not the market. Your personal experience with market volatility will largely be impacted by the actions you take before and during a crisis. Were you poorly diversified? Was your asset allocation totally inappropriate? Were you taking too much risk? Did you sell in a panic? Did you wait to get back in until the markets had already recovered? Did you stop making 401(k) contributions when things went south? Investment returns are not investor returns. Each year Dalbar does a study to see how well the average investor does compared to the markets. In short, the average investor only captures a fraction of the market return, largely because of poor behavior, so…
Sometimes it’s good to have help (especially if you’re near retirement). There are some people with the time, temperament, knowledge and discipline to handle their investments on their own. Others could benefit from a little help. This is especially true the closer you get to retirement because the issues you’ll be confronted with are different. Before retirement the major issue is saving. Most of us are at least familiar with the concept of saving (regardless of whether or not we’re doing it). We’re less familiar with the many moving parts that make up the typical retirement plan: calculating how much is enough, settling on an appropriate asset allocation, risk management, cash flow management, pension payouts, periodic rebalancing, retirement plan distributions, estate planning, Medicare, Social Security and the tax consequences of certain distribution strategies. You don’t want to mess those things up because…
Your runway is shorter now than it was during the last crisis. On average, stocks experience a 10% selloff about once every year and 20% pullback every 3.5 years. The average time of recovery for the former is about 4 months. For the latter it takes about 22 months. So while my earlier point is absolutely true—markets have always recovered—you may not have enough time to wait it out. The closer you are to retirement, the closer you are to withdrawing money from your accounts. And if you’re taking distributions while the markets are down, your money won’t last as long. So use the current crisis as a not-so-friendly reminder to…
Focus on what you can control. John Wooden once said: “The more concerned we become over the things we can’t control, the less we will do with the things we can control.” It’s easy to focus on headlines, markets and political uncertainty, but we can’t really do anything about them so it’s an exercise in frustration. We can control things like saving, debt reduction, asset allocation, and risk management, however. Focusing on those actually produces results. Unfortunately, the bull market of the last six years has lulled many into a false sense of security. Use the current volatility to make sure that your portfolio is appropriate and your plans are on track.
A lot of material crosses my desk in a given week, but one thing that caught my eye recently was a retirement report from J.P. Morgan. One of the charts in the report was titled Retirement Savings Checkpoints. If you’ve ever wondered “How much should I have saved by now?” this chart can give you a rough idea.
Just find your current salary on the top and your age on the left and then draw a line from each until they intersect. The number at the intersection point is how many multiples of your salary you should have saved by now. For example, if you make around $75,000 and you’re 55 years old then you should have about 4.1 times your salary (or about $307,500).
How much should I have by 65?
There is a general rule of thumb that says that most people need about 85% of their pre-retirement income during retirement in order to maintain their standard of living. Research done by Charles Farrell and Aon Hewitt shows that the average person can achieve that 85% replacement rate as long as they have Social Security plus 11-12 times their annual income in savings when they retire (for more on this topic read “The 15 minute retirement readiness review”). So the chart above can give you a rough idea of how much you should have saved for retirement based on your current age and income, but your ultimate goal will be to have around 12 times your annual income in savings when you retire.
That’s just an estimate of course, but it can be a helpful way to quickly gauge your progress. Ideally you’ll want to factor in the specifics of your unique situation when estimating how much you’ll need for retirement. You can do that by working with a trusted adviser or using a tool like our Ideal Retirement Design Guide.
Note: Sorry for the “radio silence” last week at the site. I was on the road visiting clients in Illinois and then spending some time in Tennessee during our daughter’s spring break. We’re trying to get her to all 50 states and Tennessee was number 22. Props to all of our Tennessee readers. We had a great time in Nashville, Franklin and Memphis.
The number one fear of retirees is running out of money. How can you create a predictable paycheck in retirement?
Step 1: Create your retirement budget.
Decide how much money you will need each month in retirement by creating a detailed retirement budget. You can download a free Retirement Budget Worksheet from our Retirement Toolkit.
Step 2: Evaluate your potential income sources.
There are 5 primary sources of retirement income: Social Security, pension, personal investments, passive income like rental property and work (usually part-time). Evaluate which of those income sources will be available to you during retirement and estimate how much income you can derive from each.
Step 3: Compare your budget with your income.
Is your anticipated income enough to cover your anticipated expenses? If not, you may need to delay retirement or find ways to trim your retirement budget.
Step 4: Decide on a claiming strategy for each income source.
With Social Security, you can claim early, on time or late. You might be entitled to spousal benefits or it might make sense for you to file and suspend so your spouse can claim benefits based on your record while your benefits continue to grow. Likewise, there are a number of strategies available when pulling money from your investments, such as dividends only, guaranteed income, systematic withdrawal, bucket strategy and a time segmentation strategy to name a few. All that just to say that for each source of income, there is usually a way to maximize that income based on your unique situation. Working with a competent adviser is usually a good idea when you get to this point. There are a lot of moving parts and the difference between a good strategy and a bad one is usually the difference between…well…a good retirement and a bad one.
Step 5: Retire. Review. Recalibrate.
Having a predictable paycheck doesn’t stop once you retire and turn on your various sources of income. Take time each year to review your withdrawal strategy and make changes as necessary. Some questions to ask yourself:
Is my withdrawal rate sustainable?
Is my income still sufficient and keeping pace with inflation?
Is my asset allocation still appropriate?
Is the amount of risk I’m taking still suitable?
Has the value of my assets changed significantly?
Has my life expectancy changed?
Your answers to those questions will help determine if you need to make changes to your investment and/or distribution strategy.
Bonus: How can I make my money last longer?
Earlier I said that one way to help extend the life of your nest egg is to maximize income from sources like Social Security. What are some additional ways to make your money last?
Dynamic Spending: Take a look at your retirement budget. How many of your expenses are non-negotiable vs. discretionary? If most are non-negotiable, then you will likely be forced to draw money from your investments during inopportune times. If, however, you’re able to set up a budget that has a certain level of discretionary spending, then you can adjust your spending based on market conditions. In down years you can put the discretionary spending on hold and extend the life of your nest egg in the process. Housing and transportation are two of the biggest non-discretionary retirement expenses. Downsizing your house and cars or entering retirement with those things paid for can give you a great deal of flexibility with your spending.
Diversification and asset allocation: Having an appropriate asset allocation helps you mange three key risks: 1) It keeps you from being too aggressive and subject to large declines. 2) It keeps you from being too conservative and subject to inflationary erosion. 3) It will hopefully help your portfolio grow consistently over time so it will last as long as you do.
Stay (or get) healthy: Longevity is a risk because the longer you live, the longer your portfolio will need to last. Even so, most of us want to live as long as possible. Staying active and healthy can save on health care co-pays, prescription costs and (biggest of all) long-term care expenses.
I kept things pretty simple in this post. When you start considering things like inflation, longevity and market fluctuations, the complexity of the predictable paycheck multiplies quickly. If you want to take a deeper dive into some of those issues, feel free to check out The Ideal Retirement Design Guide.
Some people have the time, temperament, knowledge and discipline to handle their own finances, while others could use a little help. Regardless of which category you fall into, you should seriously consider hiring an adviser to help you when it comes to retirement. Why? Because the financial issues facing a retiree are very different than the financial issues facing a pre-retiree.
Whether we do it or not, most of us are at least familiar with the concept of saving. Saving is a pre-retirement issue. We’re usually less familiar with concepts like cash flow management, determining how much we need to retire, pension payout options, retirement plan distributions, estate planning, maximizing Social Security, researching and obtaining health insurance and the tax consequences of certain distribution strategies. Those are post-retirement issues. Those are issues that most of us don’t deal with very often, so getting a little help is probably a wise move.
To help people evaluate their retirement knowledge, The American College of Financial Services recently developed a retirement literacy quiz. They gave the quiz to 1,019 Americans ages 60 to 75 who had at least $100,000 in assets. How did they do? Eighty percent of the people failed. Ouch! Fourteen percent got a Gentleman’s D. Less than one percent got an A. Those results reaffirm the point I was making earlier. Most people aren’t familiar with the types of financial issues that they will be dealing with in retirement and could benefit from some help.
I’d encourage you to take the retirement quiz and see how you do (Full Disclosure: I got 100%, but hey, this is what I do for a living!). Hopefully long time readers will do better than most since I’ve written on many of the topics before, but if you miss your fair share, consider reaching out for some help. Maybe that means hiring an adviser. Maybe it just means browsing past articles in our Archives or picking up a resource from our Store like The Ideal Retirement Design Guide. Bottom line: get some help if you need it. Don’t let mistakes derail your retirement.