Most of us have certain expectations about our retirement. We may daydream of the “golden years” as a time to explore exotic locales, perfect a golf swing, or just relax. The reality is often quite different, particularly for those who’ve done more daydreaming than planning, or who have suffered setbacks to their portfolios in 2008-2009 and feel a sense of paralysis. Knowing where to begin can be confusing, and as with most things, overcoming inertia to take that first step certainly isn’t easy. Retirement is probably the most common financial goal among individual investors, though, so we’ve decided to dedicate a series of posts to serve as a retirement primer of sorts, providing perspective on how investors can avoid common pitfalls at the starting line, at mid-career as they begin to approach the transition into retirement, and finally at the stage when they are living in retirement.
How Do You Plan for an Unpredictable Future?
For most of us, planning for retirement is a challenge on several levels. In addition to finding and committing money to save, it’s impossible to know what the future holds. How long will you live? How healthy will you be? Will you remain in your current residence? How will you generate the income you need? As the late Sir John Templeton wisely said: “Everything is in a constant state of change, and the wise investor recognizes that success is a process of continually seeking answers to new questions.”
One thing we do know is that people are living longer, and most of us don’t realize how much time we may spend in retirement. In fact, statistics suggest that you could spend up to a third of your life in retirement 1. If you are planning on Social Security to fund your retirement, it may not provide all of the income you require. So you may need to plan for a longer retirement and/or start saving earlier to help ensure your assets last a lifetime. It’s becoming increasingly important for each of us to take responsibility for our own retirement savings, and to do it sooner rather than later.
The chart below illustrates the number of people living past ages 65 and 85 in 2010, and population projections for those same ages in 2040. As you can see, current estimates suggest that the number of Americans living past 85 will more than double. With average longevity increasing, people run the risk of outliving their retirement savings. Working with a financial advisor to create a sound financial plan may help ensure that your assets last throughout your retirement years.
Save Early, Save Often
For 20-somethings, retirement may feel a lifetime away. But like death and taxes, the day when they’ll want to retire will come whether they are prepared for it or not, a fact that holds true even though some predict that Millennials (aka GenY or Echo Boomers) may find themselves working more years than their parents or grandparents did.
We’ve tapped Franklin Templeton Investments’ Gail Buckner, CFP® to explore strategies for younger investors at the first stage: Saving for Retirement. What advice does Buckner give? Save early and save often!
“If you have a retirement plan through work, sign up. If you don’t, invest in an IRA, especially a Roth. The important thing is to make saving automatic. Get the money invested before you can spend it. This is a major advantage of employer-sponsored plans where contributions are deducted from your paycheck. You can also put your contributions on autopilot by signing up for systematic withdrawals and having your custodian deduct a certain amount from your bank account each month.”
In your 20s, you may be inclined to roll your eyes as older folks make the oft-repeated lament about time flying by too fast. Before you dismiss your retirement as being something you can safely postpone another year (or more) check out this chart to see how waiting later to invest can make a big difference in the size of your retirement nest egg.
As Buckner mentioned, automation of savings is widely regarded as the more effective route to saving, but whether it’s a monthly choice or an automatic transaction, the numbers make a striking case for saving earlier rather than later. Say you are 25 years old and invest $416.67 a month in an IRA so that you achieve the maximum annual contribution of $5,000. 2
If your investments earn an average hypothetical annual return of 7%, at the end of the 10th year your account would be worth $71,675.
Now let’s assume that at this point, you stop contributing to your IRA. You also don’t take any withdrawals, and your investments continue to grow at a rate of 7% a year. By the time you are 65, your account will have grown to more than $545,000. 3 Of course, your actual return could be less—or more—depending on the performance of the markets and your asset-allocation mix.
What’s Your Risk Factor?
So how do you decide what to invest it in? In general, Buckner says the younger you are, the more you can consider tilting your portfolio toward stocks because time is your biggest ally. It can be worth taking on a bit more risk for a greater potential reward when you have decades until you retire.
“A financial advisor can help you find the right mix of investments for your risk tolerance, goals and time horizon. You should consider diversifying not just between different asset classes, such as stocks and bonds, but also in terms of U.S. and foreign securities and by market cap (large-cap, mid-sized and small-cap companies). Asset allocation has a number of advantages, but the main one is to help your money earn a consistent potential return over time, while reducing risk, which is usually defined as fluctuation in value. Dividing your money among different sectors of the markets reduces exposure to any one individual asset class.”
Many investors have heard of the traditional age-based allocation model which instructs that the amount you invest in stocks should be 100 minus your age. That is, when someone is 30 years old for example, 70% of his or her portfolio should be in stocks, while at age 70, no more than 30% should be in stocks. Buckner thinks that approach is oversimplified and can be misleading, and that one should be more flexible when thinking about asset allocation. What really matters are one’s goals, time horizon and risk tolerance, says Buckner.
“There’s no statistical data to justify the ‘100 minus your age’ model. If you are 28, and just had your first child, a key goal might be saving for that child’s education, and you have 18 years to do that. Another might be to accumulate a down payment for a home, generally a shorter-term goal. And, you also need to consider your risk tolerance. Are you comfortable with the stock market’s ups and downs? Your investments shouldn’t keep you awake at night.”
Taking Emotion Out of the Equation
Every generation of investors has faced difficult market events, be it recessions, inflation shocks, wars, and/or asset bubbles. For the newest generation of investors, the financial crisis of 2008-2009 probably played a significant part in shaping their impressions about investing. Events like these are inevitable, but an investor’s emotional reaction to them doesn’t have to be. Financial advisors can be a level-headed voice when emotions threaten to overly influence the financial decision-making process. More from Buckner:
“While we like to think of ourselves as rational and cool-headed, study after study in the field of behavioral finance demonstrates that when it comes to our money, emotions often drive our decisions, and often not in a productive or positive way. One of the biggest benefits of working with an experienced advisor is to help you avoid making financial decisions you will regret later. Too many people sit on the sidelines as if they are waiting for someone to ring a bell that signals when it’s ‘safe’ to invest. Sir John Templeton knew that the best time to invest is when the markets feel most uncomfortable; that is, when investing doesn’t feel ‘safe’ at all! But when everyone is bailing out, that’s when the bargains show up. The strategy is to buy quality investments, and to be sure you don’t overpay for them. Then, be patient.”
There’s a Reason They Call it Personal Finance
Young adults have adopted smart phones and other high-tech gadgets like new appendages. Social media have made it even faster and easier to communicate and share investment ideas. Although she uses and appreciates technology, Buckner is old-fashioned when it comes to investment advice (Buckner was one of the earliest professionals on CNBC when pundits first started giving opinions 24/7 to the masses on television).
“To me, nothing replaces the face-to-face sit-down. It’s just as important in the Facebook-age as it’s always been. Making financial decisions based upon comments from someone who knows nothing about you or your financial situation is a recipe for disaster. There’s a reason it’s called personal finance. Money is an extremely private topic.”
Of course all investors face the challenge of setting aside savings when, often, there are other needs and wants competing for their dollars. In the next post in our series, we’ll discuss the challenges of how to juggle saving for retirement with these and other complicating life events, which can accelerate in middle age.
For our retirement calculator and answers to common retirement questions, please visit the retirement section of franklintempleton.com.
New investors can read more about planning for their future in “The Importance of Getting Started.”
“Understanding Allocation” offers a primer on how to incorporate various asset classes in your portfolio.
Important Legal Information
All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.
1. Source: Mouton & Co – 2000 Individual Annuitant Mortality Table, projected to year 2011. Based on the 25% probability that a male and female aged 65 will live to age 93 and 95, respectively.
2. Source: IRS.gov. For 2012, the maximum IRA contribution is the smaller of $5,000 or one’s total taxable annual compensation.
3. This is a hypothetical example to represent the effects of compounding assets assuming an internal rate of return of 7%. It does not reflect an actual investment or any taxes payable upon withdrawal. A periodic investment does not assure a profit or protect against loss in declining markets. Returns are not guaranteed and may be less than or greater than this example. Assumes 7% annualized rate of return. Contributions made at the beginning of the period. Initial contribution is made on the 25th birthday; subsequent contributions also made on birthdays. Principal and income do not vary.