Happy New Year! What do you have planned? Need a little inspiration? Try this:
I want more purpose
I want to be happy
I want to be more proactive
I want to be healthy
I’m tired of waiting for retirement
I want to do something big
I want to finally plan my retirement
I want to be less busy
I want to focus more on things that matter
I want to avoid regrets
Am I ready to retire?
The headline from a recent study caught my eye: “Majority of retirement plans done ‘in people’s heads’ or not at all.” I think the latter is more likely. Doing a retirement plan in your head is kind of like reciting Pi out to a hundred decimal places or trying to list off all of the Samuel L. Jackson movies from memory—I don’t doubt that there are people who can do it, but most of us would give up if we tried.
Why? Because retirement plans are complicated and have a plethora of moving parts. It’s not just deciding that someday, maybe, depending on how things go, you might just move to the beach. It’s deciding what (specifically) you want to do, what that’s going to cost, and where that money will come from. It’s creating a retirement budget and a distribution strategy. It’s considering things like Social Security, inflation, longevity, sequence risk and dozens of other variables. That’s more than most of us can calculate and keep straight without bringing pencil and paper (and a computer) into the mix. Having a few vague plans in your head won’t cut it. You should have a written retirement plan. Let’s look at how to make one.
Where am I?
A good retirement plan answers three questions. Where am I? Where do I want to be? How am I going to get there? Answering the first question is fairly easy. Just sit down and gather some basic information about how much you have saved for retirement so far. Add up things like your IRA, 401(k), pension, annuities, cash value life insurance, real estate, brokerage accounts and any other assets or income streams (e.g. Social Security) that you plan to use to fund your retirement.
Where do I want to be?
Next, you need to figure out what you want to do in retirement and what those things are going to cost (a.k.a. Where do I want to be?). Your plans will drive your income needs, so you need to have a good idea of when you want to retire, where you want to live and what you want to do. All else being equal, you’ll need more money if you want to retire at 60 in Italy to join the semi-pro bocce ball league than if you want to retire at 70 in Omaha and volunteer at the humane society.
So think like a journalist and ask the who, what, where, when and why of your retirement. If you’re married, go through this exercise with your spouse. Be as specific as possible. For example, don’t just say, “I want to live in California.” Say “I want to rent a 2 bedroom condo in San Diego.” Don’t just say, “I want to get outdoors more.” Say “I want to visit all 59 National Parks.” The more specific you are, the easier it will be to estimate costs.
Which leads me to my next point. Once you have a good idea of what you want to do, you need to figure out what those plans will cost. Ignore inflation for the time being. In other words, if you want to retire at 65 and you’re 55, don’t try to guess what your plans will cost in ten years. Just do some research to figure out what they’d cost today and you can adjust that for inflation later.
To help outline your expenses, you can download my free Retirement Budget Worksheet. Go through line by line and come up with your best estimate for what you think you’ll spend each year in retirement.
Quick note: Some of you may be wondering about things like the 80% rule of thumb. That’s the assumption that many people can get by in retirement on about 80% of their pre-retirement income. In my opinion, having a specific line item budget is preferable to a general rule of thumb because it will give you a more realistic estimate of your costs.
How am I going to get there?
This is where things get tricky. There are so many variables involved with the typical retirement plan that you need to bring some expertise and computer power to bear. If you have the expertise, but just need some help with the calculations, there are a number of online calculators available. A word of warning, however. Many free calculators are very basic and make a number of unrealistic assumptions. To avoid a plan that is “garbage in, garbage out,” be sure to choose a calculator designed to do serious planning.
If you don’t have the time or expertise to do the planning on your own, it’s probably a good idea to hire an adviser who specializes in this type of planning and who has access to sophisticated planning software that factors in taxes, inflation, sequence risk and a host of other variables. A good adviser will also make sure your plan is comprehensive and covers key areas like savings goals, distribution planning, cash flow management, risk management, pension payouts, asset allocation, insurance, Social Security, Medicare, long-term care, debt and more. Finally, if there’s a shortfall between where you are and where you want to be, an adviser can help devise a plan to bridge the gap. There’s obviously a cost associated with hiring an adviser, but you will also likely end up with a plan that is more accurate, realistic and tailor-made for you.
As you can see, there is a lot of work involved in creating a written plan, but it comes with a number of benefits. Done properly, your plan gives context to your financial life. Gone are the days of just saving randomly and hoping it will be enough. With a plan, you can know for sure whether you’re on track to meet your goals. You get clarity and peace of mind. You get financial security. You get on the same page with your spouse. You get a clear vision for the future. I’ve done hundreds of these plans for clients over the years and I’ve never had someone tell me that they regret doing it. The payoff is definitely worth the effort.
Photo Credit: Nick Kelly.
The amount of debt in the world is staggering.
- Auto loans recently passed $1 trillion for the first time and the average car loan is the highest it’s ever been, recently surpassing $30,000.
- Student debt stands at about $1.4 trillion.
- Mortgage debt is about $14 trillion.
- More than 30% of households carry a balance on their credit cards. Those that do have an average balance of $16,000
- The top 2,000 non-financial companies have $6.64 trillion in debt, $2.81 trillion of which they’ve added in the last five years.
- The U.S. public debt has nearly doubled since the 2008 financial crisis, ballooning from $10 trillion to more than $19 trillion.
- 20 years ago China had $500 billion in public and private and debt. Ten years ago that number stood at $3.5 trillion. Today it is more than $35 trillion.
More than the amount of debt, however, is just how much of it has been added since the 2008 financial crisis. After experiencing a debt induced financial Armageddon, you’d think individuals, companies and governments would be hesitant to go down that road again. Not so. Record low rates have fueled trillions (with a “T” like the Titanic) in new debt. It’s like eating until you’re sick at a buffet and then deciding that the next logical step is to grab a new plate and see how many cheese enchiladas and Mini BBQ Brisket sandwiches you can fit on it.
And just like binging at the buffet is likely to end badly, binging on debt will usually end in a combination of regret and real world consequences. How is all this debt affecting us and our ability to reach our retirement goals?
It’s causing stress. A recent survey of adults with student loan debt showed that people would go to some pretty extreme lengths to get rid of that debt. Nearly 57% would take a punch from Mike Tyson. More than 40% would give up a year of life expectancy. Almost 7% said they’d be willing to cut off their own pinky finger. Think about that. A not insignificant percentage of the borrowers polled would be willing to die sooner or hack off body parts if they could turn back time and get out from under their debt. Living with excessive debt is stressful.
It’s making us financially fragile. A recent Federal Reserve survey found that 47% of Americans could not cover an unexpected $400 expense without borrowing or selling something. In other words, half the country is stretched so thin that they couldn’t afford a car repair or a new pair of glasses without some sort of payment plan. There are likely many reasons for this state of affairs, but one is most assuredly debt. In other words, we need to go into debt to fund new purchases because all of our income is already being used to pay for the debts from our old purchases.
It’s limiting our ability to save for retirement. Each year the Employee Benefits Research Institute (EBRI) conducts a Retirement Confidence Survey to see how people are doing when it comes to saving for retirement. In the most recent survey, nearly a third of respondents reported having less than $1,000 saved so far. Two-thirds have less than $50,000 saved. You don’t need to be a financial genius to know that $1,000 is not enough to fund a 20 or 30 year retirement. Even $50,000 would only get you a year or two at best. Why aren’t we saving more? Again, one reason is debt. If most of your current money is being used to pay for past purchases, you won’t have much left over for future savings.
It’s exposing retirees to market risk. Even if you are near retirement and you have no debt, you may still be at risk from debt indirectly. That’s because, with interest rates so low, many retirees have been forced to move further up the risk spectrum to get any sort of yield on their investments. It used to be that you could put your money in a risk-free money market and earn 3%. Now those same investments pay 0%. Super safe bonds don’t yield much better, so many investors are shifting more of their portfolio to lower quality bonds or dividend paying stocks. That works fine while markets are rising, but if we get another debt shock and borrowers can’t repay, then markets could tumble and many investors may find that they took on too much risk in their search for yield.
How much debt is ok?
To be sure, not all debt is bad. Debt can be a useful tool when it’s used to purchase an asset or invest in a project that helps us to generate income and pay back the debt. That said, in order to retire comfortably, the typical person needs to move from a place of low savings and high debt early in their career to a place of high savings and low debt later in their career.
What should that gradual reduction look like? To help people track their progress, researcher Charles Farrell devised a Debt to Income Ratio and then established benchmarks for different age groups. According to Farrell, your debt (e.g. mortgage, car loans, credit cards, etc.) divided by your income should be 1.25 at 40, .75 at 50, .20 at 60 and zero at retirement.
Retiring debt free used to be the rule rather than the exception. Unfortunately, that is no longer the case. In fact, a recent study by the Employee Benefits Research Institute showed that 65 percent of American families with a head of household age 65-74 had debt. The age group with one of the biggest spikes in debt was 75 and older.
That’s troubling because debt adds risk and reduces cash flow, two things that can derail your retirement. It is inherently limiting at a time when most hope for greater independence and opportunity. It increases uncertainty at a time when most people want security. So make a plan to gradually eliminate your debt and you will greatly increase your odds of having freedom, flexibility and peace of mind during retirement.
“What could cause this to fail?”
That’s what I asked myself before heading to the Grand Canyon recently for a 47 mile, Rim to Rim to Rim hike with my friend Mike. The answer, it turns out, is “A LOT of things could cause it to fail.” In fact, there’s a 400 page book dedicated solely to detailing all of the deaths that have occurred in the canyon in modern times. I know because I read it. I wanted to see all the dumb, misguided, or sometimes just unlucky decisions people made that ended very badly so I could avoid those same blunders. I like adventure as much as the next guy, but priority #1 is coming home alive. Hence my question: What could go wrong and how can I avoid it? I call this process a Pre-Mortem.
You’ve likely heard of a Post Mortem. When someone dies, the medical examiner will often do a Post Mortem exam to determine cause of death. Similarly, when a project fails at work, the team responsible for said failure will often do a project Post Mortem to determine what went wrong. Post mortems can be helpful because people can learn from them and lessons can be used to avoid future mistakes.
The downside of a Post Mortem is the Post (after) part. Whatever it is you’re examining has already gone horribly wrong and the game is over. The opportunity is gone. Others can learn from your mistakes, but your chance is gone.
A better thing to do would be to do a Pre-Mortem. Instead of “Why did this fail?” ask yourself “What might cause this to fail?” Look at your own weak points and vulnerabilities. Examine other people who have failed doing something similar. What can you learn from them? How can you avoid similar mistakes or pitfalls?
The application to retirement is obvious. Retirement is a relatively short period of time when you hope to live a secure, exciting and fulfilling life. The problem is you’ve only got one shot at it and there are a whole mess of variables, any one of which could derail your plans. By doing a Pre-Mortem, you examine your unique situation and consider the most probable things that could cause your retirement to get sideways. Then you do everything you can to plan and prepare so those things either don’t happen or you’re well equipped to deal with them if they do. Result: Retirement goes off without a hitch.
What are some of the more common things that derail retirement?
- Running out of money
- Death of a spouse
- Health issues with you or a spouse
- No clear plans for what you want to do
- Lack of friends
- Depression/anxiety due to major life change
- Market crash
- Unexpected job loss
- Family issues (children, relative, etc.)
- Caring for elderly parents
- Living longer than you expected
- High debt or other poor financial decisions
- Health care costs
- Mistakes claiming Social Security
- Mistakes with your distribution strategy
Which are the most likely to trip up your plans? Think honestly about your life, your finances, your health, your family and your friendships. What things do you honestly see as the biggest potential threats to your retirement? What can you do to either prevent them or at least be prepared to deal with them if they arise? Spend some time thinking about this now and you’ll greatly improve your odds for a successful retirement.
By the way, the Grand Canyon hike went off without a hitch. Time to rest my feet for a while and start planning the next adventure.
Not long ago, most people worked as long as they were able and eventually either “died in harness” or relied on younger family members to care for them in their old age. And then along came this idea of retirement where through hard work, shrewd investing and some help from a pension (if you’re lucky) and Uncle Sam, you could hang up your work boots a little early and spend your golden years enjoying a bit of leisure and fun. But for most people, the math of retirement only works if they’re able to earn some interest on their savings. That is a challenging task in a world where Central Banks the world over seem to have declared war on savers. What does this mean for the long term viability of your retirement? In other words, are low interest rates ruining retirement? More importantly, what can you do to keep your plans on track?
The 4% Rule
Back in the early 1990s, a financial adviser by the name of William Bengen did research on sustainable portfolio withdrawal rates. Assuming an asset mix of half stocks and half bonds, he back tested withdrawal rates against historical 30 year periods in the market. His conclusion was that if you wanted your portfolio to last 30 years, the maximum withdrawal that you should take each year is 4%. That rate has worked well for millions and many assume it will continue to work great unless future returns are significantly worse than past returns. Enter the Central Banks.
ZIRP and NIRP
The global economy has been stuck in slow growth mode since recovering from the near death experience of the 2008 financial crisis. To stimulate growth, Central Banks around the world lowered rates to pretty much zero and engaged in endless rounds of quantitative easing. When that didn’t work some of them 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, not the least of which being that it will be pretty tough for savers, pension funds and governments to meet those future withdrawal needs if large portions of their bond portfolios are earning zero instead of the 4%-5% that history has taught us to expect.
The $64,000 question (more like $64 trillion) is whether or not these low interest rates will derail retirees and the portfolios, pensions and Social Security program that they rely on to fund retirement. I can say with certainty that…it depends. If these low rates are an anomaly and they eventually return to normal, then the 4% rule of thumb that retirees rely on and the return assumptions that pensions rely on can continue to work. But if they stay this low for a long time, then retirement as we have come to know it is at significant risk. Which will it be? My gut tells me that rates will eventually rise and the 4% rule will continue to work, but it makes sense to plan for the worst even while hoping for the best.
What to do
There are several levers you can pull in order to improve your odds of success. Some are better than others. One side effect of ZIRP has been to force people into riskier investments in search of returns. That works great until it doesn’t as we saw recently when markets rang in the New Year by plummeting. Another side effect of ZIRP has been to encourage individuals, companies and countries to take on more debt. That can also work for a while, but debts eventually needs to be repaid. Are there better options?
Draw less. If a 4% withdrawal rate is too high, the most obvious way to protect yourself is to take less than 4%. I have some clients that are taking 2%-3%. Some are even taking 0% because their pension and Social Security cover their expenses. There is an extremely high probability that those taking less than 4% will be fine even if rates stay low for a long time. Of course drawing less only works if the amount you’re taking is enough to cover your expenses. That might mean you need to…
Cut retirement expenses. Examine your retirement budget for items you can reduce or eliminate. Housing and transportation are often major expenses. Consider downsizing to a smaller home or sharing a car with your spouse. Staying active and healthy can save on health care co-pays and prescription costs. Substituting planned hobbies or activities with less expensive alternatives also can trim costs without significantly changing the quality of your retirement. Taken cumulatively, these adjustments to your retirement budget can help reduce the strain on your nest egg and still provide a meaningful retirement.
Save more. Spending less is one option, but you could also improve your chances if you save more (assuming you’re not already retired). Recent research by Aon Hewitt and others shows that a person will need Social Security plus savings worth about 11-12 times their annual income in order to fund their retirement. If interest rates stay low, that multiple will be higher. If you are still working, make saving a high priority. Both 401(k)s and IRAs have higher contribution limits for people over 50. Take advantage of those limits by putting away as much as possible. The maximum 401(k) contribution for 2016 is $18,000 plus an additional $6,000 if you’re over 50. IRA contribution limits are $5,500 plus an additional $1,000 if you’re over 50. Extra additions to your portfolio could significantly improve your financial position in retirement.
Pay off debt. As I mentioned earlier, one of the unfortunate side effects of low interest rates is that the Fed is punishing savers and encouraging debtors. Debt can make sense if it’s used to purchase an asset that generates income such as a new computer for the office or a college education. Last I checked, however, a $60,000 SUV or a gourmet kitchen aren’t income producing asset for most people. When used unwisely, debt adds risk and reduces cash flow. Those things are especially troublesome to someone in retirement. By retiring debt free, you can greatly reduce the amount of savings necessary to fund your retirement.
Work longer. Working longer may not sound fun, but neither is running out of money. If low rates reduce the viability of your retirement plan, one option is to keep working and earning a paycheck. This strategy has multiple benefits: it allows you to save more, it gives your portfolio more years to grow, it could help boost your potential Social Security benefits and it decreases the overall amount of income you need to draw over the years. Of course this assumes that working longer is an option. Don’t put all your eggs in that basket in case your health doesn’t cooperate or your job skills don’t translate well in a changing world.
Delay Social Security. If you delay collecting Social Security until after your full retirement age, you will get a permanent increase in your benefits. The increase is based on the year you were born. For example, those born after 1943 will get an 8% credit for each year they wait. The increase caps out at age 70, but waiting until then will increase your benefits significantly.
Obviously, we have to deal with the world as it is, not how we want it to be. When I started my career, you could buy a 1 year CD yielding 7%. That made retirement planning much easier. Now you’re lucky if you can get 1% on that same CD. That’s just the world we live in and there’s a chance that it could persist for some time. Plan accordingly and you’ll greatly improve your odds of retirement success.
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.
Have a great weekend!
Photo Credit: Jeremy Thompson. Used under Creative Commons License.