As we go through life, there seems to be a natural progression. When we’re young, we tend to be hungry and passionate. We have a fire in our belly. We’re willing to take risks and blaze new trails.
We accept things like moving, changing jobs and making new friends as a common part of life. We’re ok living in a humble apartment filled with less than desirable roommates and hand me down furniture. We’re ok driving a sketchy car.
In short, we’re comfortable with discomfort. Partly because we don’t know any better, but mostly because we know that the discomfort is a necessary stepping-stone on the way to something better.
Then a funny thing happens as we get older. We get a better job with a better income. We upgrade our house. Buy a better car. We get the kids into private school and take on a whole mess of responsibilities. As this happens we get less willing to rock the boat. Less willing to take a risk. We’re more willing to compromise and less willing to change because along with change comes stress, uncertainty and, most of all, discomfort.
Then retirement comes. The retirement that most of us imagine requires significant life change. We’re leaving our job. A move may be involved. We’re doing new things. Trying new experiences. Saying goodbye to some people and meeting new ones. Saying no instead of yes. Saying yes instead of no. Doing those things can be intimidating and scary. They require a certain level of discomfort.
Unfortunately, we’re at that phase in life where we’re not very comfortable with being uncomfortable. The obvious risk is that we will decide to downsize, delay or even discard our dreams for retirement. Just as we’re ready to “sail, dream and discover” we decide to keep our ship at anchor instead.
I’ve seen this phenomenon many times as I help people transition into retirement. I even see the seeds of it starting to germinate in my own life. The risk is real. So don’t get too comfortable. Stay curious and open to new things. Be ready to steer off the well-worn path of the familiar and onto the road less taken. Remember that retirement doesn’t need to wait until some far off date. Each of us can start today.
Photo by a200/a77Wells. Used under Creative Commons License.
I recently had a friend who quit his job after working there for almost 20 years. When I asked him why he said, “I had just gotten too comfortable.”
Too comfortable?! Is there such a thing? After all, isn’t that what we’re all striving for? What’s wrong with being too comfortable?
As I thought about it, I think I caught his meaning. For him, comfort had become risky because:
- It was sapping his drive and motivation
- It was keeping him from taking risks
- It was making him lazy and fearful of change
- It was causing him to give up on certain dreams
He had a stable income and a warm bed, but he was starting to feel stuck and stagnate. He was comfortable, but he wasn’t feeling particularly fulfilled. Not only that, but he was afraid to do anything about it for fear that things would get uncomfortable.
Have you ever felt that way? I have. Comfort is nice, but it can be dangerous if it leaves you feeling overly content. That’s because contentment demands little. It steers you into a rut that can be hard to get out of.
This comfort paradox can be especially worrisome as we get close to retirement. Why? Comfort is often a by-product of successful retirement planning (e.g. no job, financial independence, etc.). In some ways that can be good. After all, who wants to be worried about where your next meal is going to come from or how you’re going to pay the electric bill.
Unfortunately, it can be bad too. First of all, retirement is a major transition and transitions can be uncomfortable. You’re leaving a job and a routine you’ve know for decades. You’re dealing with unfamiliar things like Medicare and Social Security. You may be moving to a new house or a new city. Being too focused on comfort can cause you to make decisions during that transition that favor short-term comfort over long-term good.
Second, retirement is the time to make your plans and dreams a reality. That means you’ll be doing new things, visiting unfamiliar places and meeting new people. To make that happen, you can’t be content to sit back and play defense.
In other words, both the transition into retirement and your lifestyle in retirement require you to get out of your comfort zone. There needs to be a tension between your desire for comfort and your desire to strive for more. If your primary goal is comfort, don’t expect great things. If, however, your primary goals are growth, fulfillment and personal satisfaction, then you can expect a remarkable retirement, but you can also expect to be a bit uncomfortable in the process.
Photo by Becky McCray. Used under Creative Commons License.
So far during 2011, the Dow Jones Industrial Average has had moves of 100 points or more on 97 trading days. That’s 23 more than during all of 2010 and the year isn’t even over yet. With so much volatility and uncertainty, it would be easy to panic and make decisions you’ll later regret. Unfortunately, your mind isn’t always wired to help. In fact, it can actively work against you. Below are seven cognitive biases that could cause you to make bad investment or retirement planning decisions, as well as suggestions for overcoming them.
This is the tendency for emotionally dominant stimuli to monopolize our attention. CNBC, I’m looking at you. Spending too much time watching the ups and downs in the market is likely to fray your nerves and cause you to sell low and buy high. Remember the words of Warren Buffett: “The market exists to serve you, not instruct you.”
This one is pretty self explanatory and was the primary driver in such spectacular failures as the internet, telecommunication and housing bubbles. When trades get completely one-sided (gold?), it’s time to ask yourself if you’re just buying or selling because that’s what everyone else is doing.
In times of stress or danger, it sometimes makes us feel better to act, even if it would be better for us to sit on our hands. A great example I heard of this recently relates to soccer. During a penalty kick the ball is kicked to the center of the net 30 percent of the time, but the goalie only stays put 6 percent of the time because he doesn’t want to look like he’s not trying. Sometimes the best thing you can do is nothing.
This is our tendency to give more weight to recent events than past events. The 2008 global financial meltdown is still pretty fresh in everyone’s mind. Eager to avoid a repeat, many are ready to move to the sidelines at a moments notice. Keep in mind, though, that during the lifetime of the baby-boomers, the S&P 500 has gone from about 17 to 1,250. That’s 73 times higher now than when the first baby-boomer was born. Don’t let the emotion of recent headlines completely overshadow the historical record.
This is our tendency for immediate gratification at the expense of the future. In a nutshell, Current You doesn’t care much for Future You. Current You wants to stop making 401(k) contributions and put the money under the mattress so he can sleep better at night. Future You needs that money saved and invested so he can afford to retire. If you want Future You to be happy, you need to convince Current You to make some decisions that are uncomfortable.
This is our tendency to give greater weight to negative information over positive. Yes, there are a lot of things wrong with the world, but there is a lot that is right. Pick any vintage from the wine cellar of history and you’re likely to find some sort of man-made or natural disaster. And yet, the economic and technological progress we’ve made over the last many decades is amazing. Admittedly, it sometimes feels like a yo-yo, but if you step back you can see that the general progression has been up and to the right.
Illusion of control
Finally, we arrive at our tendency to assume that we have more control over events than we actually do. None of us can control the debt crisis in Europe, but we can control our personal debt. We have little influence over Washington’s spending, but we can make sure our own budgets are in order. Few of us have the ear of the Social Security commissioner, but all of us can make sure that our own retirement investments are allocated properly and that we have a logical distribution strategy. In short, focus on those things you can control.
Will Rogers once said “It’s not what you don’t know that hurts you. It’s what you know that isn’t so.” The way our brains are wired, as well as the ups and downs in the markets during the last few years, have caused many to make regrettable decisions based on “what they know that isn’t so.” Hopefully understanding your brain’s natural tendencies can help you make better long-term decisions that result in a secure, meaningful retirement.
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It’s understandable if you’re feeling a bit anxious. Not only was the U.S. credit rating just downgraded for the first time in history, but over the last few years we’ve had a housing bubble, a credit bubble, runaway government spending, soaring gas prices, a global recession, high unemployment, the risk of a U.S. debt default, and a fiscal crisis in Europe.
Add to that things like the tsunami and nuclear disaster in Japan or the Arab revolts in the Middle East and you can almost see our national blood pressure rising. This is especially true if you, like 78 million other baby-boomers, are getting close to retiring.
In the face of so much uncertainty, how can you minimize anxiety and head into retirement feeling confident and assured?
Answer: Focus on things you can control.
Legendary basketball coach 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.”
Here’s an exercise that can help keep the focus on things you can actually do something about:
Take out a piece of paper and divide it into two columns. At the top of the left column, write “Things I can control about retirement.” At the top of the right column, write “Things I can’t control about retirement.” Now start filling in each.
You’ll probably notice that the right column is full of the things we mentioned earlier, like the markets, political uncertainty and unemployment.
The left column will be made up of things like saving, reducing debt, creating a retirement budget, evaluating housing options, creating a distribution plan, deciding when to take Social Security, planning meaningful pursuits and completing your estate plan.
As you look at those two columns, ask yourself this question: “During my typical day, do I spend my time and attention focusing more on the left column or the right column?” If you answered the right column, chances are that your stress level is high and your productivity is low. Focusing on things you can’t control is a recipe for frustration.
If you shift your focus to those things in the left hand column, you’ll notice that your productivity will go up and your anxiety will begin to go down. This is especially true in the area of your finances, because that is what is causing most people to lose sleep.
According to a recent poll by Gallup, the No. 1 retirement fear (held by 53 percent of Americans) is not having enough money. Only about a third of people felt that way when Gallup did the same poll in 2002. Thankfully, this is an area that you can actually do something about. Here are eight things you can do to boost your income security.
One obvious way to pad your nest egg is to save more. 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 2011 is $16,500 plus an additional $5,500 if you’re over 50. IRA contribution limits are $5,000 plus an additional $1,000 if you’re over 50.
That means that a working, married couple could delay retirement by five years and sock away an additional $280,000 simply by maximizing their 401(k) and IRA contributions. The delay also could give markets time to move higher which, when coupled with the new additions to your portfolio, could significantly improve your financial position in retirement.
Pay off debt
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. Assuming a 4 percent withdrawal rate, it takes $25,000 in savings to generate $1,000 in income each year (25 to 1).
That means if you’re mortgage is $1,300 per month and you’re able to pay it off before you retire, you could slash $390,000 from the amount you need to save for retirement.
Working longer may not sound fun, but neither is running out of money. If you haven’t saved enough, 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 recover and 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.
If the amount you need to make up is smaller, you also could consider working part-time. This could mean doing a phased retirement with your current employer or choosing something else entirely. Either way, it could give you increased freedom to begin following your retirement dreams while still providing some income.
Cut retirement expenses
If the idea of working longer doesn’t appeal to you, consider retiring on schedule and make up for any shortfall by reducing your 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.
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 percent credit for each year they wait. The increase caps out at age 70, so a person waiting until then could see an increase of 24 percent to their benefits.
Review your asset allocation
The market upheaval of the last several years and investors’ response to that upheaval has wreaked havoc on many people’s asset allocations. Rather than having a balanced, diversified portfolio, many have sought safety by moving everything to cash or bonds. That could cause serious problems in the future if inflation picks up or the bond market stumbles. To protect your assets and maximize your returns over time you should meet with a trusted adviser and make sure the investments you hold are appropriate based on your risk tolerance, goals and time frame.
Protect against sequence risk
Stock and bond returns can be volatile. Sequence risk is simply the risk that you will retire and begin withdrawing money during a period of low (or negative) investment returns. Those early negative returns greatly increase your odds of running out of money.
One way to minimize sequence risk is to have a year or two of withdrawals sitting in cash. If you retire just prior to a bull market, you can pull income from your growing investments. If you retire on the cusp of a bear market, you can take withdrawals from your cash. That way you won’t be forced to sell investments in a down market in order to fund retirement and you will be less likely to run out of money.
Draw a greater percentage from your nest egg
Deciding how much to take from your portfolio each year during retirement is one of the most important decisions you will make. You don’t want to run out of money, but you don’t want to live like Scrooge either. Most experts peg the “safe” withdrawal rate at around 4 percent per year. If 4 percent of your nest egg isn’t enough to meet your needs, you can always take more. Keep in mind, however, that the more you take, the greater the chance that you will outlive your assets.
As you can see, by focusing on those things that you can control, you can minimize anxiety and maximize security as you approach retirement. Statistically speaking, the world doesn’t come to an end very often. Rather than worrying about all the things that make headlines, focus instead on giving your very best to those areas that you can do something about.
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I originally published this article at www.fpanet.org.
As I’m sure you’ve heard by now, S&P downgraded U.S. debt one notch last Friday from AAA to AA+. Aside from the short-term angst in the markets, how will the downgrade affect those of us planning and saving for retirement? Here are three likely consequences from the downgrade as well as steps you can take to minimize the impact on your plans. Note: Just a friendly reminder—nothing on this site should be considered investment advice for your specific situation.
Expect increased volatility—This is the first time in history that our country’s debt has been downgraded from AAA. Expect continued volatility in both the stock and bond markets as traders and investors digest the news and react accordingly.
To protect your assets and maximize your returns over time you should meet with a trusted adviser to make sure that your asset allocation is appropriate based on your risk tolerance, goals, and time frame.
Also, for those at or near retirement, increased volatility means increased sequence risk. What is sequence risk? Stock and bond returns aren’t linear, and sequence risk is simply the risk that you will receive lower (or negative) investment returns in the early years once you start drawing money for retirement. Early negative returns greatly increase your odds of running out of money.
One way to minimize sequence risk is to have a year or two of withdrawals sitting in cash. If you retire just prior to a bull market, you can pull income from your growing investments. If you retire on the cusp of a bear market, you can take withdrawals from your cash. That way you won’t be forced to sell investments in a down market in order to fund retirement.
Expect higher interest rates—In an ironic twist of fate, the world responded to the downgrade of U.S. bonds by buying—you guessed it—U.S. bonds. That’s because (ratings be damned) the U.S. bond market is still the most liquid, transparent bond market in the world and investors still flock to it in times of trial.
All of that buying pushed prices higher which sent interest rates lower. Don’t expect that to last, however. Just as a person with a low FICO score can expect to pay higher interest rates to borrow money, the U.S. Government can expect to pay higher rates if bond investors perceive it to be a greater credit risk.
That’s bad news if you’re a borrower (think higher mortgage rates), but good news if you’re a lender (think higher dividends on your bond portfolio). Interest rates are at generational lows. Consider the downgrade the canary in the coal mine that they’re eventually going higher. To minimize risk and increase cash flow in retirement, set a goal to retire debt free.
Expect higher taxes—If rates go up, then the U.S. will be spending more of your tax dollars on interest payments. That’s an expense that they can little afford. In fiscal 2010, the U.S. government spent $3.456 trillion, but only had $2.162 trillion in tax receipts. That’s a deficit of $1.294 trillion. Similar deficits are projected for years to come.
To get its fiscal house in order, the government has two primary tools: cut spending and raise taxes. We all saw what a difficult time Congress had making even modest spending cuts during the debt ceiling debate. Even if they could agree on cuts that eliminated 100 percent of discretionary spending (i.e. non-military and non-entitlement), the budget would still be deep in the red. What does that mean? At some point down the road we can expect higher taxes.
How can you prepare for that? As you work on your retirement budget, assume that things like income and capital gains taxes will be higher than they are now and save enough to cover the added expense. Also, different states have different tax burdens. Some states tax Social Security and pension benefits while others do not. Sales and property taxes also differ greatly from state-to-state. As you consider where to retire, don’t forget to consider how your income, property, and purchases will be taxed during retirement. Finally, if you have some time to go before retiring, consider putting as much as possible into your Roth IRA and Roth 401(k). Distributions from those accounts during retirement are free from federal tax.
With so much uncertainty, it’s easy to get discouraged. A quick review of history, however, shows that we have always had times of volatility and uncertainty. The key is to manage through them by recognizing the challenges you face and doing everything you can to meet them head on. Do that and when times get better (which they inevitably will) you will be well positioned to benefit.
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Retirement has a lot of moving parts and when you consider that it could last for thirty years or more, it should come as no surprise that it will have several distinct phases. Sixty-five will look different from seventy-five, which will look different than eighty-five. The world, your health, your finances, your responsibilities, and your priorities, will be dynamic and ever changing. Because of that, it’s important to review your planning and circumstances each year and make whatever course corrections are necessary to keep you on track. Below is a list of questions to ask yourself each year to help determine if any changes or adjustments are in order.
1) Is my withdrawal rate sustainable? The answer to that question depends on many things, including investment performance, inflation, how long you live, and, not surprisingly, luck. Running out of money is not a pleasant option, so you should periodically evaluate your distribution strategy to see if it is sustainable. A good rule of thumb is to keep withdrawals at 4 percent or less of your overall portfolio. Everyone’s circumstances are different, however, so meet with your adviser to make sure your income lasts.
2) Is my income still sufficient and keeping pace with inflation? Inflation is constantly eroding the purchasing power of your money. That means you will likely need to pay yourself more and more with each passing year simply to buy the very same goods and services. Consider a day in the hospital. In 1980 it cost $340. That same day in 2010 cost $5,310. To offset the impacts of inflation, most people need to continue to grow their portfolio, even after retiring. That means you can’t shun risk altogether. You’ll likely need a well-diversified portfolio of stocks and bonds in order to keep pace. That leads us to number three.
3) Is my asset allocation appropriate? Simply put, asset allocation is the process of spreading your investments among stocks, bonds, cash, real estate, commodities, and foreign securities. Research shows that asset allocation is extremely important. Not only does it help to minimize risk, but studies show that it is responsible for nearly 90 percent of your overall return. As markets fluctuate you will likely need to rebalance your portfolio to get your allocation back to your intended target. In the same way, if your goals and objectives change, you should adjust your allocation to match.
4) Is the amount of risk I’m taking still appropriate? Too often people discover their tolerance for risk only after they have exceeded it. This can be a painful lesson any time, but it is devastating to someone in retirement. This is easy to see when you consider the arithmetic of loss. Any investment loss you experience requires a considerably larger gain just to get back to even. For example, if your portfolio loses 50 percent, you would need a 100 percent return just to get back to where you started. Most people in retirement don’t have the luxury of waiting around for 100 percent returns. Better to avoid the loss in the first place.
5) Has the value of my assets changed significantly? Once you retire, you need to turn your assets into an income stream. The bigger the asset, the bigger the potential income stream. Big swings in net worth, like a large inheritance or a significant market loss, affect the amount of income your portfolio can generate. You don’t want to run out of money by taking too much or live miserly by taking too little. Any time the value of your assets changes significantly, reevaluate your withdrawal rate and your asset allocation to make sure they are still appropriate.
6) Are my beneficiary designations up to date? You might not realize that your beneficiary designations (like those on your IRA, 401(k), and life insurance policies) override your will. If your will leaves your life insurance to your kids, but you never updated the beneficiary designation on the insurance policy after your divorce, your ex is getting the money. As you can see, it’s important to periodically check your beneficiary designations to make sure that they reflect your current intentions.
7) Have any of my sources of income been impacted? Personal savings is only one source of income during retirement. You will likely also receive Social Security and possibly a pension. If your spouse dies, that might cause the pension to go away or be reduced. Worse, if the company you worked for goes bankrupt, your pension might get taken over by the Pension Benefit Guarantee Corporation and be significantly reduced. Social Security is on an unsustainable path and your benefits there might be altered as well. Any changes to these other sources of income will put more of the burden on your personal savings, so monitor them closely.
8) Has mine or my spouse’s health changed significantly? At some point, the desire to live close to the beach might give way to the desire to live close to a good medical facility. As you age, investigate assisted living areas and medical facilities in your area. You might eventually need to sell your home to move into a facility or even move to another state if you want to be closer to friends or family that will be involved in your care. Do as much of this planning as possible while you are still healthy so you can easily transition into the next phase.
9) Is my estate plan up to date? Your estate plan should not be a static document. As your life changes, your planning must change with it. Getting married or divorced would likely significantly change how you want to distribute your property. Likewise if there is a death in the family. Each year you should review your documents, including your will, trust, and powers of attorney to make sure that they still reflect your wishes and still have the correct people taking charge if you were to die or become incapacitated. Also, if you move to another state when you retire, meet with your attorney to make sure that your documents will be valid in your new state of residence. Make revisions as necessary.
10) Have my insurance needs changed? Not surprisingly, your insurance needs will change over time. It’s a good idea to periodically review your policies and make changes as necessary. Is Medicare adequate or do you need additional coverage to fill certain health care gaps? Do you anticipate that you or your spouse will need assistance with basic daily activities? If so, you might want to consider a long-term care policy. Does your pension go away when you die? Will your death burden your heirs with a large estate tax bill? If so, changes to your life insurance may be in order.
For a handy PDF of this document, visit the Resources page.