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.
Quick Note: For those of you with “Retirement Planning” on your New Year’s Resolution list, I extended the $60 discount on The Ideal Retirement Design Guide through January 31st.
I have a retired client—let’s call him Mark—who was going on a trip and he asked his neighbor to water his plants and keep an eye on his house while he was gone. A year later, Mark was making a big purchase at a home improvement store and he decided to apply for a store credit card. His application was denied. This surprised him because he only had one other credit card which he hardly ever used and always paid in full. A little investigation revealed that he actually had five credit cards—four of which he knew nothing about and that were completely maxed out.
By now I’m sure you’ve guessed that his neighbor did more than water the plants. He dug through Mark’s belongings and pieced together information like his date of birth, Social Security number and mother’s maiden name and then started firing off credit card applications (American Express: Don’t leave your neighbor’s home without it.). He had the bills sent to his office address and always made the minimum payment. This meant that the accounts weren’t delinquent, but also meant that any potential day of reckoning was years away.
Anyone can be the victim of identity theft, but retirees are particularly vulnerable. They generally have good credit and available resources (they’re retired after all), both of which can be tempting targets for thieves. Not only that, but our memory can diminish as we age, a situation that criminals are more than happy to try to exploit. So what exactly is identity theft and how can you protect yourself or a loved one? What should you do if someone steals your identity? Are you liable for any fraudulent debts? How can you clear your name?
What is identity theft?
Identity theft is when someone uses your personal information to fraudulently do things like take out a loan, obtain I.D., open a credit card or gain access to your bank accounts.
Criminals use a number of tricks in their efforts to gain access to your personal information. They steal mail, go through your personal belongings (like Mark’s neighbor), scour the Internet for personal information, send “Phishing” emails and hack into computers to name a few.
The longer a criminal is using your identity, the more damage he can do, so it’s important to keep your eyes open for certain red flags such as money missing from your accounts, calls from debt collectors about debts you know nothing about, unusual charges on your credit card statements or denial of credit. Any of those could indicate problems.
What should I do if my identity is stolen?
As I mentioned earlier, it’s important to act quickly if you find a problem. Begin by placing a fraud alert on your credit report with the different credit bureaus. This will prevent thieves from causing further damage by opening new accounts. You can do this by phone or at their websites:
Once you notify one agency, they are required to notify the others. The fraud alert will last for 90 days, but for more severe cases you can extend that to seven years by filing additional paperwork. After notifying the agencies, download a free copy of your credit report and go through it to identify any fraudulent activity or inaccurate information.
Next, file a police report and obtain a copy that you can use to verify your claims as you work to fix the problems caused by the theft. In addition to the police report, file a complaint with the Federal Trade Commission (FTC). They maintain a large identity theft database which they use to assist law enforcement and affected companies with identity theft investigations. You can file a complaint at www.consumer.gov/idtheft or by calling 1-877-438-4338. One of the forms they will have you fill out will be the Identity Theft Affidavit, which you can use with affected companies to begin fixing any problems.
Once you have filed the fraud alert, the police report, the FTC report and identified the affected accounts, contact each company holding those accounts so you can notify them of the fraud and have the accounts frozen and closed. If your bank account or credit card was affected, you will need to open new accounts. Be sure to update your passwords or personal identification numbers in case those were also compromised. Once you have the problems fixed, it’s a good idea to work with the credit bureaus to clean up your credit report by having any entries related to the fraud removed from your report.
Am I liable for the fraud?
One of the first questions people often have when it comes to identity theft is “What am I liable for?” The answer depends on what form the fraud took and how quickly it is reported. You are generally responsible for $50 per card in unauthorized credit card transactions as long as you report the fraud within 60 days of receiving the bill with the fraudulent charges. Debit cards are a bit more stringent. You have only 2 days to report unauthorized withdrawals or transfers to maintain the same $50 limit of liability. Anything between 2 and 60 days will likely mean you’re responsible for up to $500 in unauthorized transfers. Anything beyond that and you risk losing the money. Not only do debit cards have a tighter reporting window, but you will also likely be without the money that was stolen until the bank can straighten things out. For those reasons, it may be worth choosing your credit card over your debit card when making purchases.
What can you do to protect yourself from identity theft?
There are several things that you can do to make it difficult for thieves to steal your identity. First and foremost, keep a tight rein on all of your personal information (e.g. Social Security number, date of birth, etc.). If you’re making online purchases or using online banking, make sure that you use strong passwords and that your computer has all of the latest security updates downloaded and installed. Run regular scans to detect any viruses or malware.
You can also place a security freeze on your credit report which will prevent credit agencies from releasing any information when they receive requests from banks or credit cards without first getting your authorization. As a result, any unauthorized application or request for a new account gets denied because the company can’t obtain the information it needs.
Finally, you might also consider signing up for a service like LifeLock to help you monitor your credit and notify you of any suspicious activity. These companies will also help fix any damage done by identity thieves. A paid service can be a good option (and give you peace of mind) if you are ever the victim of a large breach (e.g. Target stores, the Chinese hacking breach of the Office of Personnel Management, etc.) and want to keep a an eye out for anyone trying to misuse the compromised data.
When we think about compounding, we often associate it with financial success, but other areas of life—activities, travel, learning, ideas, marriage, friendships, clients, contacts, freedom, health, hobbies, religion—compound in a very similar way. Each time we get a small win in one of these areas, we can put it to work to help us grow and bring on bigger, better wins. It’s like earning interest on our interest, but the payoff is a richer life rather than just a richer portfolio.
This is a powerful idea and, with New Year’s Resolutions just around the corner, a timely one as well. As you plan for the coming year, keep in mind that the things you do with your life in the years leading up to retirement can have a huge impact on how rewarding your retirement will be. Why? Because with compounding, the really interesting payoffs come at the end.
That’s why Warren Buffett earned 99% of his wealth after his 50th birthday. Not because he somehow became a better stock picker as he got older, but because that’s when the big dollars started compounding. But he never would have gotten to that point if he hadn’t been a good steward with the small dollars.
He made his first trade at age 11 with about $200. Over time $200 became $400 and then $400 became $800. Pretty soon, thousands became tens of thousands, which became hundreds of thousands, which became millions and eventually billions. When you look at the chain of returns, you realize that the trade that got him from $1 billion to $2 billion wouldn’t have happened without the trade that got him from $10,000 to $20,000. The earlier trades weren’t as interesting because they didn’t have as many zeros, but they were absolutely essential.
Since other areas of your life can compound in a similar way, then retirement is a time that can really be exponentially cool—IF—you spend the years leading up to retirement doing the things you need to do to build your “capital” of friends, skills, experiences, self-awareness, etc. Unfortunately, we often get wound up in one or two things at the expense of others during our pre-retirement years. For example, we focus on our stuff at the expense of our relationships or our careers at the expense of our health. We promise to get to the other things “Someday.” Then we get to retirement and rather than getting interesting payoffs in the areas that matter most, we’re stuck getting from 1 to 2, 2 to 4 and so on, without enough runway to get to the really interesting numbers.
This is why I’ve often said that delayed gratification is overrated. Not because I’m impatient, but because I know that if I only start to live when I hit some predetermined age (like 65), it will be like Buffett waiting until his 5th or 6th decade to start investing. He’d still be a brilliant guy, but he would run out of time before the numbers got interesting.
And no, it’s not lost on me that sometimes non-financial compounding is at odds with financial compounding. A dollar spent today on travel or a date night with your spouse is a dollar that you won’t be able to add to your compounding assets tomorrow, but if you spend it wisely, you’ll have something else—experiences, memories, strong relationships, skills, etc.—that will then be able to compound and produce greater and greater returns over time and bring you much meaning, happiness and fulfillment. It’s up to you to find the balance between the financial and non-financial that makes the most sense for your situation. Invest wisely in both.
Seneca once said: “Life is long enough, and it has been given in sufficiently generous measure to allow the accomplishment of the very greatest things if the whole of it is well invested. But when it is squandered…we perceive that it has passed away before we were aware that it was passing.”
Ponder that thought and the aforementioned ideas on compounding as you reflect on the past year and begin planning for the next. And if you’d like a little help with your planning, just a quick reminder that The Ideal Retirement Design Guide is 40% off for the holidays.
Have a great weekend!
Tomorrow is Thanksgiving here in the good old U.S. of A., which means Christmas is right around the corner. With that in mind, I want to do two things. First, I want to wish you all a very Happy Thanksgiving! I hope you have a relaxing holiday with friends and family and have time to reflect on the many blessings in life. I’m thankful for all of you and appreciate you making Intentional Retirement a part of your reading, research and planning as you prepare for retirement.
Second, since many of you will likely begin your Christmas shopping in earnest on the day after Thanksgiving, I want to lend a hand. We don’t normally have sales in our Intentional Retirement store, but this year I’m discounting one of our most popular guides: The Ideal Retirement Design Guide is normally $159, but for the holidays I’m dropping the price to just $99. The guide is a 12 module action plan for retirement. Among other things, it includes a 72 page lifestyle design workbook, tons of worksheets, 6 Q&A case studies with current retirees and 4 hours of audio interviews with experts in areas like income planning, estate planning, long-term care and retiree taxes.
BUT WAIT, THERE’S MORE! 🙂 The guide also includes several bonus items that aren’t available anywhere else, such as my eBook 50 Essentials for Retirement Success. Give yourself or someone you care about the gift of an awesome retirement. Sure, they might get you an ugly sweater or a Snuggie, but you can give them (or yourself) the confidence and peace of mind that comes with having a great plan for what should be one of the most rewarding periods of life.
To learn more about the guide or to order, just head on over to our Store. For your ordering peace of mind, our store is administered by 1ShoppingCart, one of the biggest names in ecommerce. When you click the “Buy Now” button, you’ll be redirected to a secure product page where you can complete your order.
Thanks and Happy Thanksgiving!
Photo courtesy of Steve Snodgrass. Used under Creative Commons License.
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.
You’ve heard me say many times that:
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.